The mortgage interest rate maze

There are plenty of interest rate options available to the homebuyer when taking out or switching mortgages and this is often the area that causes the most confusion, all of which have their advantages and disadvantages depending on your circumstances. It can be confusing understanding all the features of the different products and knowing which one to choose.

Once you’ve decided on whether you are going to make payments on the capital or not, what you choose will depend largely on your current circumstances, such as whether you are a first time buyer, close to the end of your term, or what you can afford. Here are some of the options available.

Fixed rate mortgages
Fixed rates are one of the most popular interest rate options for consumers, particularly in an environment of rising interest rates. With a fixed rate, you guarantee that your rate and therefore your monthly repayments remain constant every month for a set period of time, whatever the lender does with the standard variable rate, or what base rates do. The length of time the fixed rate can run for varies depending on the mortgage you choose.

The most common fixed rate periods range between 1 and 5 years, although there are now 25-year fixed rate mortgages on the market. After the fixed rate period expires, the rate reverts to the lender’s standard variable rate, which will fluctuate along with base rates. If interest rates are rising, you remain protected against them, but should they fall, you’ll miss out on any potential reduction in your repayments.

Be careful, as many lenders will charge you a penalty if you move your mortgage before the fixed term ends. Be sure to shop around for the best deal for you and make sure you read the small print.

Discounted rate mortgages
With a discounted mortgage rate, you pay a set amount below the lender’s standard variable rate for a fixed period of time. For example, if the lender’s standard variable rate is 7 per cent and you choose a 2 per cent discount, the interest rate you will pay will be 5 per cent for the agreed term.

The terms can range between 6 months and 5 years. Generally speaking, if the term is short, the discount is likely to be greater, while for longer terms the discount is likely to be smaller. These mortgages are particularly helpful if you want to reduce your monthly payments at the outset and are comfortable that you will be able to afford the payments after the discounted period.In some cases the discount can be ‘stepped’, which means the rate reduces in two or three stages.

Capped rate mortgages
A capped rate mortgage is like combining a fixed rate with a variable rate. For example, for a defined period of time, your interest rate is guaranteed not to rise above an agreed fixed rate, but you should retain the benefits of smaller repayments should the interest rate go down. The terms can range from between a few months to the duration of the mortgage in some cases. Capped rates tend be more popular in a rising interest rate environment.

However, capped rate mortgages tend to be more expensive than fixed rate mortgages. As with discounted and fixed rate mortgages, you may incur a charge if you move your mortgage before the end of the agreed period of the offer.

Variable rate mortgages
This is essentially the lender’s standard variable rate. It will be higher than any introductory interest rate and your repayments will generally go up or down with base rate changes. Most borrowers will find themselves better off with an alternative special interest rate option, particularly if you switch when introductory offers come to an end. Be aware of any charges that might be incurred for switching mortgages before taking any action.

Tracker rate mortgages
Tracker rates are relatively new mortgage options whereby the interest rate you pay is guaranteed to stay at a certain level above the base rate. The rate will then remain within that set level above the base rate, whether it goes up or down, usually for the term of the mortgage. For example, you might find a deal whereby you pay 1 per cent above the base rate, whatever it may be or change to. Although you pay more of the base rate rises, you will benefit from any reductions in the base rate over the term.