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First of all, let's look at how interest rates are calculated in the first place. There are two figures that you need to know in order to know if the interest rate you are paying is fair. The first is the Bank of England Base Rate. This is set by the Monetary Policy Committee (MPC) on the first Thursday of every month. Then there is the LIBOR. This is the London Inter Bank Offered Rate and is best explained as the rate at which banks can borrow from each other. Banks will borrow money from each other in order to lend it to mortgage borrowers so it is important as should the payable rate of interest be low LIBOR then the bank is losing money
Now we know these two, let's look at the way interest is calculated on a mortgage. As a general guide, mortgages interest rates need to include the amount the lender paid to borrow the money, plus the administration costs they had in setting up the mortgage for you. Additionally, they will want to take account of the risk of the customer and also room for some sort of profit. However, this is how the interest is calculated for the standard variable rate mortgage - otherwise known as the variable rate mortgage. But there are many different types of mortgages. We shall now look at how interest rates are calculated for the different mortgage types.
Fixed Rate - Fixed rates are normally calculated by finding out how much interest the bank has to pay to secure the money from the banks and offering that amount or above for the length of the deal
Capped Rate - This depends on what the Bank of England Base Rate is, which governs the standard variable rate. If it is low, then the capped rate will be high enough to attract make some money for the lender whilst being low enough to attract customers
Cashback - The cashback interest rate will be higher than the normal interest rate charged to take account of the cashback that you receive.
Discounted - these would be related to the standard variable rate, and will be low enough to bring in customers. It then goes up and down with the SVR.
Flexible - The interest rate would be set to take account of the flexible nature of the product, where over the life of the mortgage the lender may earn less interest
Current Account - Again, the interest rate takes account of the fact that the features of the current account mortgage mean that over the length of the mortgage the lender could earn less interest.
Tracker - tracker mortgages are linked to the Bank of England base rate and will simply go up and down with the base rate.
Do you like certainty? Do you like to know what your monthly outgoings will be with as much certainty as possible? If your largest regular expense is fixed for a period time, would that be a great advantage to you? If so, perhaps a fixed rate mortgage is for you.
With fixed rate mortgages it sets the interest rate you will pay for a specified period. This will guarantee the amount that you pay for each month for the agreed period of time. Once the fixed time period is at an end, your repayments will be at the lender's standard variable rate.
The obvious advantage of this is that should you need to budget carefully over the first few years of your mortgage, you will be able to with a fixed rate deal. You will know how much you have to pay each month, and should the base rate rise you will not be caught out with sudden increases in payments. Should the interest rate rise above the fixed rate that you are paying, you will actually be saving money in real terms.
Don't forget that the reverse of this is also true. If the interest rates go down whilst your fixed rate deal is in place, then you will lose out. However, you will at least still know how much money will be coming out of your account each month, and there is a value on that.
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