Whatever mortgage you negotiate, an ordinary repayment mortgage or one of the various types of interest only mortgages, the amount of your monthly and total outlay in repaying the loan will depend on the interest rate that is applied to the original mortgage. As we will discuss below, there are several different
interest rate options available. Choosing the right one for you can result in considerable savings. The first of the options that we will consider is the fixed rate mortgage.
The Fixed Rate Mortgage
The fixed rate mortgage is what is says on the pack. The lender and the borrower agree, in the mortgage deal, that the interest rate will be fixed for a certain period of time. This means that the borrower knows exactly what his interest payments will be until the end of that period. This is attractive, because it allows for clear budgeting for a period that may be anything from three to five years. The benefits of a fixed rate mortgage are even greater if there are significant rises in the base borrowing rate during the course of the fixed rate period. However, if there are significant reductions in the interest rate, a borrower with a fixed rate mortgage can find that he is paying substantially more than a borrower who took out a variable rate mortgage from the outset.
The fixed rate mortgage, therefore, brings certain risks, not least because it can be extremely expensive to get out of the arrangement early. It dies, however, have the advantage of certainty, at least over a limited period. When the fixed term ends, the mortgage returns to the vagaries of the variable rate.
Having considered the fixed rate mortgage, we will now look at a second type of mortgage interest type, namely the variable rate mortgage.
The Variable Rate Mortgage
The variable rate mortgage is also what it says on the pack. The interest that the lender charges the borrower is based upon the Bank of England base interest rate. Obviously, this rate varies from time to time, causing the variable rate mortgage to similarly vary. The interest on the variable mortgage is not pegged to the Bank of England base rate. It is higher, by a varying number of percentage points, according to the lending institution and/or the financial circumstances and history of the borrower. When the Bank of England Monetary Policy Committee decides, after one of its monthly reviews, to increase the base rate (normally as a means of controlling inflation) the lending institutions will increase their variable rate. They will lower the rate when the Bank of England decides to lower the base rate, although not frequently as quickly! The benefit of having a variable rate mortgage is that, in times of recession and low interest rates, the mortgage payments that the borrower is making can plummet. Conversely, in times of rampant inflation, as in the 1980s, borrowers can find that interest rates are so high that they simply cannot afford to maintain their instalment payments. Inevitably, in those circumstances, they end up losing their home.
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