When purchasing a property, there are certainly a lot of things to consider and when it comes to mortgages, there can sometimes be a steep learning curve to transcend. Thankfully, for our clients, this is where we as a broker come in as we can help explain everything they need to know.

In this article, we’re looking at how mortgage interest rates work and what they are. A good place to start is probably explaining that question ‘what is the interest rate on a mortgage’. The answer to this is simple as when you take out a mortgage, your lender will charge interest for using their services.

Generally, this will be a percentage of the total amount you borrow, and you pay this on top of your agreed loan repayments. Different mortgage products have different interest rates, and it’s important that you take this into account when picking the right product as a higher rate means higher payments!

How Do Mortgage Interest Rates Work?

As mentioned above, generally mortgage interest rates are calculated as a percentage of the amount you borrow. In terms of how things work when you come to paying the mortgage back then depend on whether your mortgage is a repayment or interest only mortgage.

For example, if you take out a repayment mortgage you will be paying back the amount you borrowed plus any interest in the form of monthly payments. This means that a portion of your monthly payment will go towards reducing the overall loan and the remainder will go towards interest costs.

Interest is then generally calculated based on the total balance that is remaining each month. Because you are making capital repayments, the total amount of interest you end up paying will decrease over time and a larger portion of your payment will go towards paying off the overall loan.

When it comes to an interest only mortgage, the total loan amount becomes due at the end of the mortgage term and the only payments made are towards interest. This generally means that monthly repayments are lower and a common use for interest only mortgages is with a buy-to-let mortgage for example.

How Is Mortgage Interest Calculated?

Calculating mortgage repayments based on a mortgage rate can seem complicated, however, it’s actually very simple. If we take a 1.3% interest rate and apply it to a £240,000 mortgage what you need to do is take the interest rate, divide it by 12 and that is the amount of interest you pay each month.

• The illustration here is calculated by: Interest rate ÷ 12 x total remaining loan
• Calculation: (0.013 ÷ 12) x £240,000 = £260 interest

If your monthly payment is £760, then £500 will go towards paying the debt down and £260 towards interest.

For example, this will then give you a balance of £239,500, so you will pay (0.013 ÷ 12) x £239,500 = £259.46 interest the second month. Therefore, a payment of £500.54 will go towards your capital and so on.

What Is A Fixed And Variable Mortgage Rate?

Put quite simply, a fixed mortgage rate means that your interest rate will not change for the given period (usually two or five years). This is attractive for homeowners as it means that your monthly payments are predictable, however, it also means that you could face a penalty in the event you wish to pay off the loan early. It also means that, if the market changes and interest rates drop, it is difficult to benefit.

When it comes to a variable rate, it simply means that your interest rate (and monthly payments) can go up or down. Your lender will give you a full breakdown of how this is calculated as it can vary from one product to the other.

Generally, when you take out a mortgage you will start off on a fixed rate and then after a period of time, move onto a variable rate. This is the point people tend to consider remortgaging as it not only fixes in their rate to something that could be more favourable, but monthly repayments could also drop.

If you are looking to purchase a property and need advice on your mortgage, simply contact us and our team will be more than happy to help.