How Mortgage Rates Work

Your mortgage interest rate is the rate charged by a lender to borrow from them. A fixed-rate mortgage offers a set percentage that won’t change. With a variable rate mortgage, like a tracker mortgage, rates can go up or down. Discount mortgages follow a standard variable rate set by your lender.

John Fitzsimons Published on 16 April 2021. Last updated on 07 September 2021.
How Mortgage Rates Work

When you take out a mortgage, you are charged interest on the money you have borrowed.

Interest rates matter because they ultimately determine how expensive your mortgage is ‒ the higher the rate, the more interest you will have to pay on the mortgage, and the more your home will cost you overall.

Fixed vs variable rates

A big consideration for any borrower is whether the interest rate on their mortgage is fixed or variable.

With a fixed-rate mortgage, you know precisely what the interest rate ‒ and therefore your monthly repayments ‒ will be for a specific period, which can run from two years up to as long as a decade. The big selling point is the certainty this provides ‒ it’s easier to budget if you know what your repayments will be for years to come.

And because of that certainty, fixed rates can cost a little more ‒ initially at least ‒ than variable-rate mortgages.

With a variable rate, your rate is, well, variable! That means it can go down, lowering your monthly repayments, or up, resulting in higher monthly mortgage bills.

A common form of variable rate is a tracker mortgage. As the name suggests, the rate you pay tracks the base rate set by the Bank of England.

Alternatively, there are discount mortgages, which follow the standard variable rate (SVR) set by your lender but offer you a reduction on it for a certain period of time, for example, a 1% discount for two years. Each lender has its own SVR, and it can increase or decrease it at any time, irrespective of what is happening with the Bank of England’s base rate.

Once you reach the end of your initial fixed, tracker or discounted period, you’ll move onto the lender’s SVR until you pay off the mortgage or remortgage to a new deal.

How are mortgage interest rates worked out?

There are a few different factors that go into the interest rate charged on a particular mortgage.

A big one is the Loan-To-Value (LTV), which is how the size of the loan compares to the overall value of the property. For example, if you want to buy a £200,000 house and have a £50,000 deposit, then you need a mortgage for £150,000. That works out at 75% LTV.

Lenders design their products based on LTV tiers ‒ up to a maximum of 60% LTV, 70% LTV, 80% LTV, etc. The higher the LTV, the higher the interest rate is likely to be.

Mortgages often come with an application fee, which could set you back the best part of £1,000, maybe more. Some lenders offer fee-free options but these are likely to come with a higher interest rate.

The size of the loan can play a part too. Lenders will set minimum and maximum loan sizes for particular products, and may offer products for larger loan sizes which come with a different interest rate.

Another important consideration will be your credit record. Some lenders will be less willing to consider your application if you have black marks on your credit history, like a missed or late payment. And as a result, you may need to turn to a specialist lender, who may charge a higher rate of interest.

» MORE: How to check your credit

How can I compare mortgage interest rates?

As lenders develop a wide variety of products, it’s really important to shop around to ensure you get the best possible deal.

You can do this yourself by visiting the websites of different lenders, but this can be a pretty arduous process.

A much quicker option is to make use of NerdWallet’s comparisons, which lets you identify mortgage deals that might meet your needs.

Alternatively, you could make use of a mortgage adviser. Independent advisers can steer you toward lenders that are most likely to accept your application, while they also have access to some lenders and products that you won’t get as a direct borrower.

» MORE: Mortgage adviser vs. direct lender

How can I improve my mortgage interest rate?

There are a number of steps you can follow which might improve the interest rate you’ll pay on a mortgage. The first is simply to shop around ‒ different lenders have different product ranges, and it’s unlikely that the bank you have your current account with will offer you the best deal.

Lowering the LTV of any loan you go for will also make a difference. If you are buying your first property, that may mean waiting a bit longer so you can save a larger house deposit or speaking to family members about whether they can help you out by supplementing your deposit.
Improving your credit score will also make a big difference. Lenders are always most confident lending to borrowers they feel they can trust to keep up with their repayments, so if you want to qualify for the best possible rates, you’ll need to show them why you are a good prospect.

Image Source: Getty Images

About the author:

John Fitzsimons has been writing about finance since 2007. He is the former editor of Mortgage Solutions and loveMONEY and his work has appeared in The Sunday Times, The Mirror, The Sun and Forbes. Read more

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