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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.
A flexible mortgage is used as a catch-all name for a number and variety of mortgage products which enable you as the borrower, rather than the lender, to decide when and how you will make repayments. Most flexible mortgages will allow you to overpay and underpay your mortgage repayments.
Overpaying is where a borrower repays as much as they want at any time, enabling themselves to cut the interest they pay, as interest is recalculated daily. Underpayment is where a borrower can take payment holidays or even borrow back sums that they have overpaid. Both of these can be done without penalty. Be careful though, there are now over 30 lenders using the term 'flexible' to describe their products, and they don't always mean the same thing. You should treat all claims with caution and look into the products closer, even if the biggest lenders offer them.
The realities of the employment world today dictate that many people have found themselves changing jobs frequently, either by choice or otherwise, or having periods out of work, or working for several people at the same time. This means that regular monthly repayments can be like a millstone around their neck. Not just because of the fact that they have to pay each month, but the fact that they can't pay more than the regular payment should they receive a bonus or come into a sum of money.
Flexible mortgages are often an excellent product for first-time buyers. If they are able to make overpayments on their mortgage now, then that could provide a cushion for them should they encounter future expenditure rises e.g. due to starting a family or an interest rate rise. In the case of this happening, it is very useful to be able to take a payment break.
Whilst every truly flexible product should allow overpayments and underpayments without penalty, many loans may not meet all of the criteria due to caps and limits that lenders put on them. There should be watched out for.
Some people may have a higher income than usual and may want to pay £100 a month or so over their normal monthly payment, but their lender will only allow an overpayment if it is £1000 or more. This is unrealistic, as is when a lender puts an upper limit on overpayments as well. As for underpayments, some 'flexible' mortgage providers will put restrictions on payment holidays, or not allow the borrowing back of credit that they have overpaid.
Flexible mortgages are not for everyone. Some people need the discipline of having to make repayments regularly. Otherwise, they may never pay off their loans, which is one of the benefits that product providers have of providing these mortgages.
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