If you’ve been following the news lately, you may have seen that the Bank of England have indicated that it will be raising the ‘Base Rate’ of interest to 4%. However, you might not be sure what this means for you and your mortgage.
In this article, we will be explaining what happens to mortgage rates when interest rates rise, what types of mortgages are affected and which are not.
Inflation and the Bank of England Base Rate
Inflation is the rate at which prices rise over time. If inflation is high, the Bank of England may increase its base rate to help slow it down.
A higher base rate tends to make borrowing more expensive and saving more attractive, which reduces spending and increases saving, easing pressure on prices. The effect takes time, though, and inflation is influenced by other factors too.
The base rate is one of the factors that lenders consider when setting their own rates, but it isn’t the only influence. Their funding costs, expectations about future interest rates and business decisions also matter, so an increase does not mean every mortgage rate will rise by the same amount.
Likewise, a fall in inflation does not automatically mean mortgage rates will fall. Lower inflation means prices are rising more slowly, not necessarily that they are falling. The Bank will consider the wider economy before deciding what to do with its rate.
Fixed, Tracker and Variable Mortgages
Your mortgage type determines when a rate change might reach your household budget.
Fixed-rate mortgages keep the same interest rate for an agreed period, often two or five years. Your rate does not change during that period because of a base rate move, although your payment could still change for another reason, such as a change to your mortgage balance or term.
When the fixed deal ends, you can review the options available. If you take no action, you will usually move to your lender’s standard variable rate, which may be higher. Check your mortgage paperwork for the terms that apply.
Tracker mortgages follow a named rate, usually the Bank of England base rate, plus a set percentage. For example, a tracker at ‘base rate plus 1%’ would charge 5% if the base rate were 4%. If the tracked rate rose by 0.25 percentage points, the mortgage rate would normally rise by the same amount. The timing depends on the product terms.
Other variable-rate mortgages, including standard variable rates, are set by the lender. They can change after a central bank decision, but they do not necessarily follow it exactly. The lender decides when and by how much to change the rate.
Financial Markets and Fixed Mortgage Rates
Lenders do not have to wait for a Bank of England decision to change the fixed rates they offer. Fixed-rate pricing reflects what financial markets expect interest rates to do over the coming years, as well as lenders’ funding costs.
Lenders add a margin to cover costs and risks and to make a return, but it’s important that they remain competitive on price. As a result, a lender may raise or lower a fixed rate before the base rate moves. A cut does not guarantee cheaper new mortgage deals.
A Mortgage Cost Example
An interest rate rise can make a noticeable difference to the monthly cost of borrowing. The size of the change depends on the balance, remaining term, rate and repayment method.
For illustration, take a £200,000 repayment mortgage with 25 years remaining, assuming the rate stays unchanged for the full term, and there are no fees:
- At 4% interest, the payment would be approximately £1,056 a month.
- At 5% interest, it would be approximately £1,169 a month.
That is around £113 more each month. These are illustrations, not average payments, current deals or personal quotes. A repayment mortgage payment covers interest and gradually reduces the amount borrowed.
On an interest-only mortgage, the monthly payment covers interest rather than reducing the loan. For the same £200,000 balance, interest alone would be about £667 a month at 4%, or £833 at 5%. The £200,000 would still need to be repaid at the end of the term.
You can use Mortgage To Home’s monthly mortgage repayment calculator to estimate a payment using different figures. The result is a guide, not a recommendation.
Your Next Deal and the Rate Lenders Offer
If your fixed rate is ending, compare the payment you make now with the cost of a new deal. Even if the base rate has recently fallen, the new rate could be higher than the one you fixed years ago.
You can look at a new deal with your existing lender, known as a product transfer, or consider remortgaging with another lender. Compare fees as well as rates. Check for early repayment charges before leaving an existing deal, and allow time to review your options before it ends. Mortgage To Home’s remortgage advice explains the options in more detail.
A fixed rate gives payment certainty for its agreed period. That can help with budgeting, but you may pay more than borrowers on a variable rate if rates fall. Your fixed deal could also cost more than a newly available fixed rate. A tracker can fall as well as rise, so consider how much room your budget has for an increase.
The rate available to you also depends on your circumstances. Lenders consider credit history and loan-to-value, or LTV: the mortgage amount compared with the property’s value. A lower LTV can give access to lower rates. Neither the base rate nor your credit history is always the more important factor; lender criteria and market conditions both matter.
Buying a Home or Letting a Property
Higher mortgage rates can affect first-time buyers’ budgets and borrowing options. Lenders assess income, spending and existing commitments, and may test affordability against a higher assumed interest rate. A larger monthly payment can reduce the amount a buyer can borrow.
That makes it useful to plan for costs beyond the deposit, including mortgage fees and other buying expenses. Mortgage To Home’s information on first-time buyer mortgage advice in Dewsbury provides a relevant next step for local buyers.
Buy-to-let rates can change too. Landlords, particularly those with interest-only mortgages, may see a larger share of rental income go towards mortgage interest when their rate rises. Lenders may also assess expected rental income against mortgage costs. The rules and products available vary by lender.
Help with Rising Mortgage Costs
If payments are becoming difficult, contact your lender early. Do not wait until you have missed a payment. Your lender can discuss the support and options available for your circumstances.
For example, extending a repayment mortgage term may reduce the monthly payment. It can also increase the total interest paid over the life of the loan. Changing to interest-only may be possible in some circumstances, but the balance still needs to be repaid. Ask about the long-term costs and any effect on your credit record before agreeing to a change.
Your home may be repossessed if you do not keep up repayments on your mortgage.