Interest Rates
By signing a mortgage contract, you are agreeing to repay the lender the sum you have borrowed, plus an interest charge. Interest is essentially the cost of borrowing. The size of the interest charge varies based on the interest rate, which is, to a certain extent, based on your personal circumstances; if you have poor credit history for example, the interest rate will typically be higher. The interest rate is stated in terms of a percentage of the amount borrowed, and represents the total percentage you will pay each year. If the interest rate is five percent on a one hundred thousand pound loan, you are charged five thousand pounds interest over the year.
As the interest rate affects the interest charged and therefore the overall cost of your mortgage, you will need to decide what type of interest rate your mortgage should have: this is an important part of the process as it will directly affect how much you pay back and how you plan for your mortgage repayments. Make sure you research a wide variety of mortgage deals; a small reduction in the interest rate can make a huge difference to your monthly repayments.
Some mortgages have a fixed interest rate, which means that the percentage amount you pay in interest will stay the same for an agreed period: typically between two and five years, depending on the mortgage and lender you choose. There are also mortgages where the interest rates are variable. This means that the interest you pay can change from month to month: for more information see Variable Rate Mortgages.
Further interest rate options include: tracker rate mortgages, where the interest rate is directly linked to a recognised variable interest rate such as the Bank of England's base rate; capped rate, where the interest rate will not exceed a certain amount for a set period; and discounted rate, where the interest rate is lower than the mortgage lender's standard variable rate for a set period. In some cases, your religious beliefs will forbid you from paying interest on a loan and you may choose to take out a home purchase plan instead: these are popular with the Muslim community.
Effect of the Economy
Changes in the economy may affect your mortgage's interest rate. How severely your interest rate is affected depends on the type of interest rate you have chosen. For example, a tracker rate directly follows the Bank of England's base rate, which means that if the base rate rises, your mortgage's interest rate will also rise. If you have a fixed rate mortgage, your interest rate is set, so changes in the economy should not affect the size of your repayments. However, if the base rate falls, you could end up paying too much interest.
The Bank of England's base rate can be changed by the UK's Chancellor of the Exchequer, who is responsible for economic and financial stability. Essentially, if the Government wishes to promote spending, the base rate is reduced; if the Government wishes to encourage saving and investment, the base rate is increased so that saving becomes more profitable, because higher interest rates increase the value of savings more quickly. Therefore, if the government wishes to encourage saving, perhaps because of economic instability, you may pay more interest on your mortgage.
