Why interest rates change
Mortgage interest rates are closely linked to the base rate. This is set at the start of each month by the Bank of England’s Monetary Policy Committee and they move it up and down with the aim of keeping inflation at a low and constant rate.
Mortgage lenders’ standard variable rates are typically between one and two percentage points higher than the base rate. So, for example, if the base rate was 5%, most standard variable rates would be between 6% and 7%. If the base rate increases, your mortgage rate is likely to increase as well, and by roughly the same amount.
Mortgage lenders make special offers to new customers, and these typically last for between two and five years. Most lenders will charge you a redemption penalty if you want to move your mortgage before the special offer expires so check these out before choosing a deal. A few mortgages charge redemption penalties after the special offer period has expired, but these deals are rarely competitive and are best avoided.
Fixed rate mortgages
Fixed rate mortgages are ideal for those who are on a tight budget or are worried that interest rates might increase significantly. As the name implies, the amount you pay each month is fixed for set period of time, usually between two and five years. Historically, fixed rates have been the most popular option among homebuyers.
Discounted rate mortgages
A discounted rate is a set discount, say 1%, compared with the mortgage lender’s standard variable rate. So if the base rate moves, your discount rate is likely to move as well.
Tracker rate mortgages
Although mortgage rates tend to move when the base rate does, there is no exact link between the two. In fact, many people believe that mortgage companies are very quick to pass on interest rate rises and slow when it comes to falls, sometimes even not passing on the full amount of any cut.
This has led to the invention of the tracker mortgage. These are variable-rate mortgages but ones which have an explicit link to the base rate. For example, a tracker mortgage could offer the base rate plus one per cent.
Capped rate mortgages
Capped mortgages are relatively rare. Essentially they are variable mortgages but with a guarantee that the interest rate will never rise above a set level. They tend to be quite expensive relative to other types of mortgage.