When embarking on the exhilarating journey of buying your first home, navigating the intricate world of interest rates can seem like deciphering a foreign language. Fear not, for in this FTB Basics series, we're unravelling the mysteries to empower you with the knowledge you need.
So, what exactly are interest rates? These are used to calculate the amount of interest you will pay on your loan. Imagine them as the toll you pay for borrowing money. You secure a mortgage from a bank or lender, and the interest rate is used to calculate the charge you incur for this privilege. Your monthly mortgage payments will most likely consist of a tiny portion of repayment of the borrowed amount (known as the loan principal) and the interest calculated from the interest rate. Typically, you receive the entire loan sum upfront and gradually pay it back little by little over the mortgage term (usually 20-25 years).
There are many factors which will influencing the interest rate you are offered, usually its tied to your chosen mortgage product. Majority of first-time buyer mortgages come with fixed interest rates spanning 2, 3, or 5 years as a start, to provide stability for the first period of monthly payments. And when this fixed period comes to an end, you will be invited to opt for a different rate or transition to the lender's Standard Variable Rate (SVR).
Virtually every single interest rate product from every single lender can be traced back to the Bank of England (BOE) Base Rate, which is why to hear so much about it in the press. Changes to this rate ripple down to all other loan interest rates unless you have fixed yours for a set period. No matter what happens with the BOE Base Rate during the term of your fixed period, your ongoing interest rate will remain unchanged (since that is the whole purpose of fixing the rate). But, if interest rates change during your fixed period, then you will be affected by any changes at the end when you need to decide to re-fix or transfer to the variable rate. The benefit of fixing your interest rate is that you give yourself a time buffer to prepare your finances for any changes.
If you don't like the idea of fixing your interest rate, your mortgage interest will either be transferred to either a variable or tracker rate. Here's the kicker: You will not have a time buffer against increases in interest rates. Rate changes will happen almost at the same time that the rates change. There is only one major difference between a variable and tracker rate in that variable rates change at the lender's discretion, while trackers follow external rate fluctuations (often the BOE Base Rate). They still fluctuate and rate changes are more immediate.
Now, the million-pound question: which rate to choose? Opting for the cheapest isn't always the wisest. If the lowest interest rate option is a tracker or variable rate, consider the implications of future interest rate hikes and if you can handle sudden changes to your mortgage costs. If you are right up against your affordability threshold, a fixed rate will act as a security blanket, even if it's currently higher than variable options. This insurance-like stability guards against sudden mortgage cost escalations, offering peace of mind and a delay to the hit on the wallet.
No one-size-fits-all answer exists for interest rate selection. Your unique financial portrait will shape the choice which is best for you. While your mortgage broker can highlight your options, the interest rate product you choose is ultimately your decision. Armed with knowledge and understanding each rate type's nuances can help you select the interest rate that will be best for you.
So keep learning and keep being empowered while you hunt for your first home.