Types of Interest Rates

Types of Interest Rates

Once you’ve decided on whether you are going to make payments on the capital or not, you need to turn your mind to interest rate options. There are many different ways of calculating the interest due – all of which have their advantages and disadvantages, depending on your circumstances. Add to this a number of other special types of mortgages – and you have a lot to choose from.

Standard Variable Rate (SVR)

The simplest form of loan is one which sets its interest rate according to the lender’s standard variable rate, or SVR. With a loan like this, your interest payments are likely to rise or fall every time there is a change in the Bank of England’s base rate. However, lenders don’t always pass on the change in Base Rate – this can be to your disadvantage if the rate falls but your interest rate doesn’t.

Most borrowers are transferred to their lender’s SVR once their initial, promotional rate period comes to an end.

Pros

There are usually no early repayment charges on these loans.

Cons

The unpredictability of interest rate movements makes it hard to plan your finances, and the costs of your mortgage may rise rapidly if interest rates go up.

Discount Rate

A discount mortgage offers a reduction (“discount”) of a given amount on the lender’s standard variable rate. If the SVR changes, the rate you pay will fluctuate in line with the change but at the same level of discount (e.g. 0.5% below SVR).

Usually, the greater the discount is the shorter the period of discount will be. After the discount finishes, the loan reverts in most cases to the lender’s SVR.

Pros

You can make a significant saving on the standard variable rate.

Cons

Discount mortgages often incorporate significant early repayment charges, which may make it expensive for you to remortgage to another rate or lender.

Fixed Rate

A fixed rate loan charges a set rate of interest for a predetermined period, and then usually reverts to the lender’s standard variable rate. The fixed rate will often be very competitive, however when you revert to the lender’s standard variable rate you’ll find that this is much higher.

Pros

A fixed rate loan offers you the security of knowing how much you’ll be repaying during the initial period which can make budgeting much easier.

Cons

If the Bank Base Rate is dropping, your fixed rate may actually prove to be more expensive than a discount or tracker rate. E.g. you may tie in to a fixed rate which is the “best ever” but the market may continue to drop, leaving you on a higher rate but unable to move due to early repayment charges.

Capped

A capped rate will not rise above a certain level for the cap period – offering similar security to the fixed rate. You can have confidence that your interest rate will not exceed the cap, whatever happens to the lender’s standard variable rate. The initial rate is usually competitive, however the deal will often also incorporate early repayment charges.

Pros

A capped rate offers you the security of knowing that your monthly payments will not rise beyond a certain level during the initial rate period, and therefore it will be easier for you to budget than it would were you on a tracker or variable rate.

Cons

As a payback for the security of the capped rate, rates are often higher than a fixed rate and the initial cap term seldom lasts longer than 2 or 3 years.

Tracker

A tracker rate gives you the certainty of knowing the rate you pay will move automatically in line with Bank Base Rates. You benefit straight away from any reduction in Bank Base Rate, even if the lender delays reducing its standard variable rate to reflect the reduction.

Tracker rates often track Bank Base Rate by a certain percentage, e.g. Bank Base plus 0.75% for the full term of the mortgage.

Many tracker products also offer flexible terms.

Pros

A tracker rate means that you immediately benefit from any reduction in Bank Base Rate – which is particularly beneficial in times of low Base Rates.

Cons

If the Bank Base Rate increases, your interest rate will also move up, while those on capped or fixed rates keep their low rate for longer.