14th April 2023
The mortgage rate refers to the amount of interest you're charged on the loan you took out against your property. The amount you pay will depend on many factors, including the length of your mortgage term, your deposit amount and whether you have a fixed or variable mortgage.
In this article, we're going to take a closer look at what mortgage interest rates are and answer the frequently asked question, ‘how are interest rates calculated?’.
Mortgage interest is calculated as a percentage of the amount you borrow. This interest is then repaid over the length established by your mortgage deal, which is known as the ‘term’. The majority of mortgages are repayment mortgages, meaning that alongside paying off the interest, you also pay back a portion of the amount you initially borrowed. The goal is that, by the end of the term, you will own the property outright. It's important to bear in mind that the longer your mortgage term, the more interest you will have to pay in total.
Some mortgages are also interest-only, which means you only pay the interest that is charged on the loan. In this scenario, you will still owe the amount you borrowed against the property at the end of the mortgage deal.
find me a mortgageThe type of mortgage you choose will influence the amount of mortgage interest you have to pay. The most common mortgage types are:
With a fixed-rate mortgage, the interest rate stays the same for the period of your mortgage term. This period usually lasts between 2 and 5 years. This type of mortgage means you can budget a lot easier for your repayments as you know exactly what you’ll be paying back each month.
With a variable-rate mortgage, the lender can adjust the interest rate you pay during the course of the term. This means the rate could change from month to month, making it harder to budget. While the Bank of England’s interest rate can influence what you pay, this ultimately comes down to the lender.
One benefit of variable-rate deals is that they typically allow overpayments, so you can pay off your mortgage early and benefit from paying less interest overall.
Tracker mortgages are similar to variable-rate mortgages, however, they are more closely linked to the Bank of England’s base rate. This means the interest rate for this type of mortgage will be more heavily influenced by factors like inflation, consumer confidence and employment figures. During economic downturns, interest rates can increase significantly.
Mortgage interest rates are expressed annually, so you need to divide your interest rate by 12 to work out the percentage applied to your payments every month.
(mortgage rate ÷ 12) x remaining balance = monthly interest charge
For example, if you take out a £200,000 mortgage with a 3.4% interest rate, you will pay £567 in interest in the first month based on the calculation above.
(0.034 ÷ 12) x £200,000 = £567
If your monthly payments are £950, the remaining £383 will go towards your mortgage balance.
This then leaves you with a balance of £199,617, meaning you will pay £566 in interest in the second month.
(0.034 ÷ 12) x £199,617 = £566
This pattern continues each month until your balance is paid off.
Many factors can influence your mortgage interest rate. The main ones include the Bank of England’s base rate, as previously mentioned, but also the policies of the lender you choose. All mortgage providers, such as banks and building societies, have to offer competitive prices to attract customers, but they also have to balance this with risks and rewards.
Here's a closer look at the factors which will impact how your mortgage interest rate is calculated:
The mortgage market is a very competitive industry. One of the main factors that influence mortgage interest rates is how competitive lenders are. If lenders want to attract more customers, they will usually offer more attractive rates. On the other hand, if they want to lower the amount of new business coming in, they might increase rates instead.
Your credit history is another factor that will influence your mortgage interest rate. If you’ve ever struggled with paying back debt or keeping up with repayments, you could have a low credit score. If lenders see a low credit score, they may be wary about offering you a mortgage, choosing to off-set this risk by charging you a higher interest rate.
Another big influence on your mortgage interest rate is the amount of risk to the lender. If you were to default on your mortgage, the lender would need to consider how they could recover their losses, so they'll typically turn to the LTV (Loan-To-Value) ratio here. Essentially, the more money you want to borrow, the more risk there is to the lender.
Another factor to consider is where the lender gets their money from. Lenders will source their money through various means, meaning the money you borrow for your mortgage may have actually come from the market or the savings deposits of existing customers. Lenders will also consider their capital or liquidity when setting mortgage interest rates.
When it comes to comparing mortgage interest rates, you might be familiar with the APR (annual percentage rate) figure. Before March 2016, consumers used to see this percentage applied to mortgages but it has since been replaced by the APRC (annual percentage rate of charge) figure. Both are intended to illustrate how much interest homeowners will repay when they take out a mortgage:
The aim of the APRC is to be much more comprehensive in scope so that you can clearly see how much your mortgage will cost you per year until it is paid off unless you switch to a different deal or provider. Lenders must make the APRC visible to avoid any confusion when comparing mortgage interest rates.
Hopefully, this guide has given you a clear answer to the question ‘how are interest rates calculated?’. Get in touch with us for free initial advice at WIS Mortgages or use our mortgage calculators today to see how much you can afford.
As a mortgage is secured against your home/property, it may be repossessed if you do not keep up with the mortgage repayments.
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