If you’re a first time buyer or someone who’s moved around a couple of homes, you may have always wanted to know how the figure that you pay is calculated. Not just the overall payment, but the monthly payments too.
That’s why, in this blog, we’re going to help you understand how mortgage interest is calculated so you can be more informed about your new or upcoming mortgage payments.
What is Mortgage Interest?
Mortgage interest is essentially the percentage that shows you how expensive it’ll be to borrow the money for your home. So, whatever the original house price was, you’ll have to pay more money on top at an agreed ‘interest rate’.
This is seen as a value exchange between you and the lender - you’re getting the home without having to pay full price up front, and they get interest paid back to them for allowing it.
Your interest rate can vary over your lifetime depending on many factors, such as:
- The Bank of England is changing interest rates
- You being on a variable interest rate
- Your personal circumstances (credit score, loan-to-value ratio, etc)
- Economic instability
If you’re on a fixed-rate mortgage term, you don’t have to worry about this until your term ends. However, you may be met with a higher interest rate depending on all the factors discussed above.
How Does Mortgage Interest Work?
Mortgages are calculated based on a number of factors, including your income, credit score, and the type of mortgage you choose. The main factors that affect your mortgage payment are:
Following on from the loan to value (LTV) section, the lender will have less risk (the higher your deposit) and, as a result, offer products with lower interest rates. Counter to that, a smaller deposit, as low as 5% attracts the highest mortgage interest rates, and as you are also borrowing more, the monthly payment will be higher.
EXAMPLE: If you borrow £300,000 over 25 years at an interest rate of 5%, your monthly repayment would be around £1,753. If you instead borrowed £250,000 (because you put down a bigger deposit) at a 4% interest rate, your monthly repayment would drop to around £1,319, saving you over £400 a month.
What Other Factors Affect Mortgage Interest?
Your income and credit score will also affect the amount of mortgage you can afford. Lenders will look at your income to see how much you can afford to pay each month. They will also look at your credit score to see how risky you are as a borrower. A higher credit score will mean that you are less risky, and you will likely qualify for a lower interest rate.
There are a number of different types of mortgages available, and the type you choose will also affect your monthly payment. Fixed-rate mortgages have a set interest rate for a product period, usually 2, 3 ,5 or even 10 years which means your monthly payment will stay the same.
Variable-rate mortgages have an interest rate that can change over time, which means your monthly payment could go up or down.
What Do Mortgage Rates Look Like for Different Types of Mortgages?
There are three types of common mortgages - one of these will most likely be the one you choose:
- Variable-rate mortgages
- Fixed-rate mortgages
- Tracker-rate mortgages
Let’s look at what interest rates look like for each one.
1 - Variable-rate Mortgages
The monthly repayments will all depend on your lender, meaning your mortgage repayment could go up and down. This makes it a lot more difficult to budget for, but you can also take advantage of it when interest rates are low (you will be affected negatively when interest rates rise, however).
2 - Fixed-rate Mortgages
No matter what’s going on, good or bad with interest rates, your monthly payment will remain the same for the specific term you agreed to. This is great for knowing exactly what your repayments will be, but also, you may lose out on saving money when interest rates are lower (the same goes the other way, though).
3 - Tracker-rate Mortgages
Tracker-rate mortgages depend less on your lender and moves more in line with the Bank of England Base Rate, but will work similarly to variable rate mortgages. If interest rates rise, you pay more… if interest rates fall, you pay less each month.
Should You Always Rely on Mortgage Calculators?
Mortgage calculators are a great indicator of what you could potentially be paying each month for your mortgage. However, with there being so many factors involved in calculating your mortgage repayments, it’s almost impossible to get an exact figure.
Lenders don’t use the same calculations as a mortgage calculator - they also do affordability checks, income stress tests, age restrictions, and many more that can’t simply be put through a calculator.
That’s why, ultimately, the amount of mortgage you can afford will depend on your individual circumstances. It's important to speak to a mortgage adviser to get more tailored advice.
How Do Lenders Set Mortgage Interest Rates?
There are a few factors on how mortgage lenders will set mortgage rates, which include:
- Using the Bank of England's Bank Rate
- The policy your sepcific mortgage lender has
- The type of property
- Market conditions (swap rates)
- Your personal creditworthiness
- The competitiveness in the market at that point in time
- Many more!
There are so many factors and this is why sometimes, mortgage interest rates can change daily.
Do You Need Mortgage Advice?
If you’re struggling to understand your own situation and how you can save the most money on your mortgage, then it may be worth speaking to a mortgage advisor, similar to what we do here at Bell Financial Solutions.
Instead of stressing about how you’re going to go about this in the most money-efficient way, you work with our team who are fortunate enough to have 5-star reviews from all of our amazing customers, who can give you a plan of action on where to go next.
To get in touch, you can either call us on 0161 791 4757, or use the contact form on our website to speak to a qualified member of staff. We look forward to hearing from you!
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