Types of mortgage interest rates

Once you have established what type of mortgage need you have and the most suitable way of repaying your mortgage you will need to decide what is the best type of mortgage interest rate for you.

This section will explain the main types of mortgage interest rate. They will not necessarily all be available to you from a particular lender or for the type of mortgage need that you have.

Table of contents

Variable Rate Mortgage

This is the most common type of mortgage interest rate in the UK. A variable interest rate mortgage offers you a mortgage at the lender’s basic mortgage interest rate, commonly known as the Standard Variable Rate (SVR).

This can fluctuate with interest rate changes made by the Bank of England. If the mortgage rate rises you will pay more each month. Naturally, if the mortgage rate falls so will your mortgage payment.

The main advantages of this type of interest rate are that:

there are usually no penalties for cancellation and for transferring to another mortgage product or to another lender (known as redemption penalty and lock-in periods). You therefore have the flexibility to change your mortgage type or move to a different lender.

there are few, if any, additional fees to pay such as are often present with fixed rate, discounted rate and capped rate mortgages.

The main disadvantage of this type of interest rate is that when interest rates generally increase sharply, your interest payment instalments are likely to increase substantially.

Fixed Rate Mortgage

A fixed rate mortgage offers you a mortgage with an interest rate that is set for a period of time, usually between 1 to 10 years. The rate then reverts to the lender’s basic mortgage interest rate.

The main advantage of this type of interest rate is that knowing the interest instalments will not fluctuate during the fixed period allows you to plan your finances.

The main disadvantages of this type of interest rate are that:

general interest rates may fall and you will have to continue paying the higher fixed rate or suffer a large termination penalty.

these mortgages sometimes have early cancellation penalties that can lock you into staying with the lender for a time after the fixed period. This could then tie you into an uncompetitive mortgage.

application fees can add to the cost of the mortgage.

Discounted Rate Mortgage

A discounted rate mortgage, as its name suggests, offers a set discount from the lender’s standard variable rate for a set period of time. Normal terms are between one and five years.

The main advantage of this type of interest rate is that you pay less than the standard mortgage rate. In addition the initial interest rate you pay can be lower than that of a similar fixed rate or capped rate mortgage. Repayments will reduce further if the interest rate falls.

The main disadvantages of this type of interest rate are that:

when interest rates generally increase sharply, your interest payment instalments are likely to increase substantially.

these mortgages sometimes have early cancellation penalties that can lock you into staying with the lender for a time after the fixed period. This could then tie you into an uncompetitive mortgage.

the longer the period of discount the smaller the discount.

application fees can add to the cost of the mortgage.

Capped Rate Mortgage

A capped rate mortgage offers you an interest rate with a maximum rate for a set period of time. This means that during the capped period, your interest instalments will not rise beyond the capped amount even if interest rates increase sharply.

In other words, the capped rate is the most that you will pay, but if the variable rate falls below the ‘cap’ you will pay the lower rate.

The main advantage of this type of interest rate is that while you are protected from increases in rates, you will benefit from any falls in interest rates.

The main disadvantages of this type of interest rate are that:

these mortgages sometimes have early cancellation penalties that can lock you into staying with the lender for a time after the fixed period. This could then tie you into an uncompetitive mortgage.

application fees can add to the cost of the mortgage.

the most competitive capped rates are normally initially more expensive than the most competitive fixed rates. Therefore, this type of scheme is most suited to borrowers who believe that interest rates will fall in the foreseeable future.

Cash Back Mortgage

A cash back mortgage is generally a standard variable rate mortgage which can provide you with a significant cash sum on completion of the mortgage, typically 5% or 6% of the amount borrowed.

It is possible, also, to combine a cash back with the other types of scheme available, for example fixed and discounted rates, though, in such cases, the level of cash back would usually be lower than normal. This cash may be attractive to first time buyers who need extra cash for home improvements or furniture.

The main advantage of this type of interest rate is that the lump sum can be used at your discretion and can be attractive to those who require the funds to make home improvements or repay a termination penalty on an earlier fixed rate mortgage that now has an uncompetitively high interest rate.

The main disadvantages of this type of interest rate are that:

when interest rates generally increase sharply, your interest payment instalments are likely to increase substantially.

rates are usually set at the lender’s standard variable rate for a fixed term with early cancellation penalties that can lock you into staying with the lender. This could then tie you into an uncompetitive mortgage.

application fees can add to the cost of the mortgage.

Tracker Rate Mortgage

A tracker rate mortgage offers you a variable rate mortgage with an interest rate that rises and falls in line with a specific benchmark, usually the Bank of England Base Rate.

The tracker rate would be expressed as a certain percentage rate above the benchmark rate.

The main advantage of this type of interest rate is that there are usually no penalties for cancellation and for transferring to another mortgage product or to another lender (known as redemption penalty and lock-in periods), giving you the flexibility to change your mortgage type or move to a different lender.

The main disadvantage of this type of interest rate is that when interest rates generally increase sharply, your interest payment instalments are likely to increase substantially.

Risk Factors

Your home may be repossessed if you do not keep up monthly repayments on your mortgage.

The Money Advice Service information sheet ‘You can afford your mortgage now, but what if …?’ will help you consider the risks.

You can obtain a free copy from https://moneyadviceservice.apsmos.com/ViewArticle.html?sp=Sengyoucanaffordamortgagenowbutwhatif-136

Links to more information

Important

This information does not constitute personal advice and should not be treated as a substitute for specific advice based on your circumstances.

Information given relating to tax legislation is based on my understanding of legislation and practice currently in force. Whilst I believe my interpretation of current law and practice to be correct in these areas, I cannot be responsible for the effects of any future legislation or any change in interpretation or treatment. In particular you are warned that levels of tax and tax reliefs are subject to alteration and, in any case, the value of such reliefs and benefits may depend on an individual’s circumstances.

If you are in any doubt as to whether any course of action is suitable for you, then you should discuss the matter with a suitably qualified independent financial adviser or other specialist.