Mortgage interest rates explained

Mortgage interest rates determine how much you'll be charged to borrow and buy a property, and what your monthly repayments will be. Find out how they work and how to get the best mortgage interest rate.

Which? Money team
Last updated: Nov 2018

In this article
How are mortgage interest rates set?
What mortgage interest rate will I pay?
Which mortgages come with the lowest interest rates?
How do I get the best mortgage interest rate?

Where can I compare mortgage interest rates?
Are mortgage interest rates going up?
Get expert advice on finding the best mortgage interest rate
How are mortgage interest rates set?
There are a host of different factors that go into how a lender sets the interest rates on their mortgage range.

The cost of funds
The first thing to consider here is how the lender is funding their mortgages. The cheaper they get that funding, the lower they are able to set the rates. This can vary enormously between lenders - while some will rely on raising deposits from savers, others look to get their funding through the wholesale markets, while some go for a mix.

While the Bank of England base rate does play a part, there’s not really a clear link between the base rate and what lenders have to pay to get their funding.

The loan-to-value
The larger the deposit you have, the lower the interest rate you’ll be able to get. If you’re buying with a 40% deposit, then you’ll qualify for much better rates than if you’re buying with a 10% deposit.

It comes down to a question of risk. If you are borrowing at a high loan-to-value then you won’t have much equity in the property. As a result, if you default on the loan, the lender is more likely to make a loss.

However, if you are borrowing at a lower loan-to-value, there is less chance of the lender losing out in the event of you defaulting.

Competition
Another factor in the pricing of interest rates will be the level of competition in the market, and a lender’s own business targets.

If a lender wants to be a dominant player in the mortgage market for that year, then it will look at how its competitors are pricing their loans and use that to work out what interest rate they are comfortable lending at.

Equally, if they feel that their lending is already ahead of schedule, then they are likely to start increasing the rates they offer, in a bid to attract fewer borrowers.

If you want to know which companies combine top rates and excellent customer satisfaction, read our guide to the best mortgage lenders.

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Your credit history
Your record as a borrower in the past will have a significant bearing on the mortgages you might qualify for. For example, if you have missed a few payments in the past, whether on credit cards, personal loans or even your mobile phone bill, black marks will be left on your credit report.

Not all lenders will consider borrowers who have these black marks in their credit history, and those that do will often charge a higher interest rate as a result of the perceived additional risk of lending to you.

Find out more in our guide to bad credit mortgages.

Fees and charges
Mortgage lenders don’t just make their money from the interest they charge on the loan - most products come with an application or product fee too. These are often around £1,000, and can be paid either up-front or added to your mortgage balance, though doing the latter will cost you more as you will pay interest on it.

Lenders may also have a range of products that do not come with any such fees. However, this is balanced out by a larger interest rate.

For example, a 75% loan-to-value deal, fixed for five years, might charge you 2.09%, but comes with a £999 product fee.

However, there may also a fee-free version available at 2.39%.

What mortgage interest rate will I pay?
Mortgages broadly fall into two main categories - fixed rates and variable rates.

With a fixed-rate mortgage, your interest rate - and therefore your monthly repayments - are fixed for a certain period. This can be as short as two years or as long as 10 years.

There are also variable interest rates. These come in a couple of different types.

Tracker deals follow the Bank of England’s base rate. Your rate might be described as the 'base rate + 2%', which means that your current interest rate was 2.5%, but as the base rate changes, so too will your interest rate.

These deals might be as short as two years or run for the entire term of the mortgage.

Discount variable rate mortgages deal follow the lender’s standard variable rate (SVR), which the lender sets and can change at any time, but at a discount.

Find out more in our guide to the different mortgage types.

Which mortgages come with the lowest interest rates?
Generally, the interest rates on fixed-rate mortgages will be larger than those on offer from variable deals.

With a fixed rate, you know precisely what your repayments will be for the duration of the fixed term. But with the variable rate, it could change at any time. That certainty that comes with a fixed rate also brings with it a premium - if you want to know what your repayments will be every month, then you will have to pay for it.

The same thinking applies with longer fixed-rate deals of five years or more. The lender is taking on a bigger risk by offering these deals - they are guaranteeing you that interest rate, irrespective of what may be happening with the central base rate, for an even longer period.

So, if you want certainty over your repayments for a lengthy period of, say, five years, then that will cost more than the same certainty for two years.

How do I get the best mortgage interest rate?
The right mortgage for you will depend on your circumstances and what you want from a mortgage. However, to qualify for the most competitive rates on offer, there are certain conditions you will need to meet.

Firstly, you will need to have an excellent credit record. Lenders are very thorough in checking your credit history when assessing your application - they want to know that you are confident in handling credit, so the better your credit score, the better your chances of being approved.

Find out more in our guide to how to improve your credit score.

The best rates are reserved for borrowers with the highest deposits, and the cheapest deals tend to be for those who have a 40% deposit either as a first-time buyer or for those buying their next property.

It's vital to shop around. There are dozens of different mortgage lenders, from the big names that you are familiar with seeing on the high street, to challenger lenders who are exclusively online. Each will have a whole range of different products on offer, so there are a lot of different deals to sift through.

Many borrowers opt to go through a mortgage broker. Not only are they familiar with the different products on offer, but they have access to mortgage deals which are only available through advisers.

Which? Mortgage Advisers can discuss your mortgage options and will recommend the right deal for your needs. Call 0808 256 8710 for a free consultation today.

Where can I compare mortgage interest rates?
There are many price comparison sites that allow you to compare mortgage interest rates, based on your own personal criteria.

It's important, however, to not focus solely on the rate that a lender offers, but the total cost of the mortgage across the term of the deal. This way, you'll factor in fees and charges associated with the mortgage deal, as well as the interest being charged.

For this reason, the lowest rate may not necessarily mean you'll get the cheapest deal.

You can compare mortgage interest rates on Which? Money Compare, which allows you to compare mortgage deals on both price and the quality of service you can expect to get.

Are mortgage interest rates going up?
While the Bank of England base rate is not the only factor affecting mortgage interest rates, it has a strong influence on how they are set.

The Bank increased the base rate in August to 0.75% and, since then, lenders have generally passed that increase onto borrowers. Most lenders have increased their standard variable rate mortgages, and fixed-rate mortgage rates have also been on the rise.

It is anticipated that the base rate will rise again over the next 12 months, which lenders will factor in when assessing whether or not you can afford your mortgage.

So, while many people have benefitted from years of low mortgage rates, we are in a period where they are more likely to rise in the future, rather than go down.

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