Interest Rates: How Do They Work?
7th March 2018
A mortgage is the biggest financial commitment most of us will make. The interest rate can make a big difference to the amount you’ll pay each month, so it’s important to understand how this rate works in order to get the right deal.
Interest rates: How do they work?
Borrowing money comes at a cost, and that cost is called interest. You have to pay back interest on top of the money you’ve borrowed - this gives the lender an incentive to lend.
Interest is calculated as a percentage of the loan amount. The bigger your mortgage, the more impact your interest rate will have on what you’ll pay.
How the base rate affects your monthly payments
The research for our Mortgage Saver Review showed that fewer than a quarter of borrowers understand how the base rate affects their monthly payments.
It’s important to understand that although the base rate can play a role in determining interest rates, it’s not the defining factor.
A change in the base rate affects the cost of borrowing across the finance sector, and these changes are ultimately then passed on to borrowers. The Bank of England controls the base rate, so lenders can change their rates to reflect such changes.
For example, most base rate trackers follow the Bank of England base rate which determines their movement, not the lender.
The base rate has been as high as 12% and hit a historical low in 2017 at 0.25%. That’s why it’s a good idea to consider locking in a low rate when the base rate is low.
How different types of mortgage affect your interest rate
Variable rate mortgages such as tracker deals don’t have a fixed interest rate. Instead, tracker rates follow the base rate. Tracker rate deals tend to track a few percentage points above the base rate but are often lower than fixed rate deals when the base rate is low.
Fixed rate mortgages are generally a popular choice as they provide stability, making it easier to manage your monthly payments. Around 95% of Trussle customers opt for a fixed rate deal, often to guarantee stability but also to lock in a low rate when the base rate is low.
If you’re on a fixed rate deal, your payments won’t increase even if the base rate goes up.
How to compare interest rates
Interest rates alone don’t give you the whole picture of what you’ll pay for your mortgage. It’s important to look at the true cost of a deal to factor in any added costs, as fees alone can total thousands of pounds. In January 2018, research for our Mortgage Saver Review showed that the upfront cost for Santander’s lowest rate was £1,534 - you could fly to Australia and back twice for that!
Remember that high fees can sometimes outweigh the savings of a lower rate, especially while interest rates are low.
A good mortgage broker will always recommend deals based on the true cost.