Interest Rate Types

A few weeks ago, we did a blog discussing fixed rate mortgages. A fixed rate mortgage represents just one of the interest rate types available to those looking for a new mortgage deal. In today’s blog, we’re going to look at all interest rate types and discuss the pros, cons and when each is most appropriate.

The interest rate type is a factor related to the initial product term of the mortgage. After the initial product term, the interest rate will change to standard variable rate (SVR). SVR is determined by each lender and changes in line with market conditions.  All non-fixed rate mortgage types are often grouped under the phrase variable rate mortgages. This is because, as the name suggests, the interest rate on these types of mortgages vary during the initial product term. However, this is not to be confused with SVR.

Fixed rate mortgages have an interest rate guaranteed for the initial product term. This allows security in the monthly mortgage payments. If interest rates rise or fall, those on a fixed rate mortgage will not be affected. While a fixed rate is great for budgeting and more often than not the cheapest option, these mortgages can have their downsides. As mentioned, in times where interest rates are falling, those on fixed rates will not be able to benefit from this. Fixed rate mortgages almost always have significant early repayment charges associated with them. This means if you want to leave the mortgage before the end of the fixed rate, you will have to pay a charge to do so. However, as with most mortgages, fixed rate mortgages are normally portable. If you want to move house before your fixed rate ends, you can move (port) the mortgage to the new property without incurring any charge.

Tracker mortgages are the most common type of variable rate mortgage. Often referred to as base rate trackers, they follow the Bank of England Base Rate and move up and down when this changes. A set margin is added on top of the base rate to determine the interest rate offered to borrowers. Tracker mortgages are typically the most appropriate and cheapest option when looking for a mortgage with no early repayment charges. This can be needed if you’re only intending to stay in the property short term and don’t want to commit to a fixed rate option. Another example would be a borrower looking for a further advance but not wanting the two tranches of their mortgage to become out of sync, potentially tying them to the current provider long term. In times where interest rates are falling, tracker mortgages can allow you to take advantage of general interest rate drops. However, in the current climate where interest rates are rising, those on tracker rate mortgages have seen monthly payments rise.

Discount mortgages are type of interest rate determined by the lenders SVR. The rate is a set discount below SVR with the figure subject to change as and when the lender changes their SVR. As with the Bank of England Base Rate, SVR changes generally occur in line with economic conditions. Borrowers’ monthly payments rise and fall depending on the direction of change. Discount mortgages are less common than tracker mortgages but it is not uncommon for them to be the cheapest variable rate option in the market. Discount mortgages also tend to have no early repayment charges, providing borrowers with the same flexibility that comes with a tracker rate.

Lastly, there is another interest rate type where the mortgage rate is linked to an index. The most recognised of these is LIBOR which is calculated based on what banks estimate they would be charged to borrow from other banks for short-term financing. LIBOR linked mortgages use the LIBOR figure as a benchmark for determining an interest rate to be charged with a set margin then added on top. These mortgages have recently been phased out however other mortgages linked to other indexes still exist. SONIA is an example of this. Unlike LIBOR, SONIA is based on actual transactions. In today’s market, these types of mortgages are extremely uncommon and rarely appropriate for the vast majority.

There are various add-ons that can be applied to the above mortgage types mentioned. Capped and collared rates refer to when variable rate mortgages have upper and lower limits defined at outset. However, these are scarcely seen on mortgage products across the market today. Offset mortgages are another type of mortgage. These utilise a fixed rate and we’ll discuss more about offset mortgages in a future blog.

Different interest rate types are suitable for different people in different circumstances, be it impacted by personal or wider economic conditions. If you’re looking for a new mortgage deal or you have any mortgage and life insurance queries, we’re here to help with free, professional advice.