How do interest rates affect mortgage payments?
After interest rates spiked during the cost of living crisis, those with mortgages were hit particularly hard. Here, we'll discuss why interest rates are so high and how they affect your mortgage.
After interest rates spiked during the cost of living crisis, those with mortgages were hit particularly hard. Here, we'll discuss why interest rates are so high and how they affect your mortgage.
What are UK interest rates currently?
When looking at the Bank of England base rate history, the base rate was at a historic low of 0.1% in December 2021. In August 2024, the Bank of England base fell to 5%. This was the first drop since the start of the pandemic in March 2020.
The base rate set by the Bank of England is used by other banks to set their own interest rates. Interest rates are used to calculate the cost of borrowing (e.g. loans and mortgages) as well as the interest paid on savings (e.g. current accounts and savings accounts). This means the Bank of England base rate has huge influence over the finances of the UK.
Why are interest rates so high and when will they fall?
After interest rates rose consistently during the last two years, the Bank of England decided to lower them for the first time in four years in August 2024.
Upon announcing the drop, they stated that "we need to be careful not to cut rates too quickly or by too much." This implies a desire to cut rates further in future, but this is far from certain, given the current climate.
Rising interest rates were an attempt to control inflation. Soaring inflation was caused by rising energy costs and Russia’s invasion of Ukraine severely impacting supply around the world. As long as the war continues, the economy may continue to face challenges. This makes interest rate predictions difficult to make.
What do high interest rates mean for mortgages?
If you were wondering “are mortgage rates going up?”, it depends on the type of mortgage you’re on. An interest rate rise will affect your mortgage differently:
Fixed-rate mortgage
If you’re on a fixed-rate mortgage, you don’t need to worry about higher interest rates yet. Your mortgage rate and monthly repayments will remain the same for the agreed period of time (three years, five years, etc.), regardless of whether interest rates rise or fall.
However, once your fixed term ends, you’ll automatically be moved to your mortgage lender’s standard variable rate (SVR), which is guided by the Bank of England base rate. If this has risen, you’ll likely pay a higher interest rate on your mortgage, likely raising your monthly payments.
Discounted, tracker or SVR mortgage
A discounted mortgage is a deal that offers a fixed discount on the lender’s standard variable rate (SVR). For example, if the SVR was 6.5%, your mortgage could be a fixed discount of 1%. This would make your mortgage rate 5.5%. However, if the standard variable rate then changed, your mortgage rate would change in line with this. So, for example, if the SVR rose to 7%, your discounted rate would rise to 6%.
Tracker mortgages are another type of variable rate mortgage, but they’re linked to the Bank of England base rate. As an example, a tracker mortgage could be set 1% above the base rate. In December 2021, this would mean your mortgage rate would be 1.1%. However, in August 2024, it would have risen to 6%. In this example, your mortgage rate will have almost increased sixfold, significantly raising your monthly repayments.
If you’re simply on a standard variable rate mortgage, your mortgage rate could change at any time. This means your monthly payments could go up or down over the course of your mortgage term.
Interest-only or repayment mortgage
With an interest-only mortgage, you only repay the interest on the loan. This means you’re not repaying the capital during the term of the mortgage, unless you make an overpayment or switch mortgage types. Because you’re not repaying the capital of the loan, your monthly repayments will usually be lower than a repayment mortgage.
With an interest-only mortgage, you pay interest on the same balance for the full mortgage term (unless you make an overpayment on the original capital). At the end of the term, you must repay the balance in full.
With a repayment mortgage, you’re repaying both the interest and capital on the loan. This means, if, for example, your mortgage is £200,000 at 6% over 30 years, a portion of your £1,199 monthly payment would go towards paying off the £200,000, while the rest would be paying the interest on that balance. Over the course of the mortgage term, the proportion of interest you’re paying will decrease, as you continue to pay off more of the balance.
How do interest rates affect monthly mortgage payments?
If the rise in interest rates has caused your mortgage rate to rise, your monthly mortgage payments will also cost more.
Here’s a breakdown of how much more a repayment mortgage could cost each month, based on the mortgage rate increasing:
| Mortgage balance | 2% mortgage rate | 4% mortgage rate | 6% mortgage rate |
|---|---|---|---|
| Monthly repayment on a 25-year mortgage term | |||
| £100,000 | £424 | £528 | £644 |
| £200,000 | £848 | £1,055 | £1,289 |
| £300,000 | £1,272 | £1,583 | £1,933 |
| £400,000 | £1,696 | £2,110 | £2,578 |
What are the changes to Stamp Duty?
In September 2022, the government changed the way Stamp Duty works for buyers in England, Wales and Northern Ireland. They’ve increased the initial threshold, from where you start paying Stamp Duty tax, from £125,000 to £250,000. For first-time buyers, the threshold has increased from £300,000 to £425,000. The exact amount you’ll pay in Stamp Duty will depend on the property’s value.
Should I remortgage now or wait?
Since August 2024, after the Bank of England dropped interest rates for the first time in four years, it's not surprising people are wondering whether to stick or twist on their mortgage.
If interest rates continue to fall, then you may regret locking into a fixed rate now. Upon announcing the drop to 5%, the Bank of England said "we need to make sure inflation stays low. So we need to be careful not to cut rates too quickly or by too much." This may indicate a desire to lower rates further in future, but this is far from certain.
If you’d like the certainty of knowing what you need to pay each month, a fixed-rate mortgage will provide that for you. That way, you know your mortgage repayments won’t change for the duration of your deal. This will avoid any nasty surprises and allows you to budget for that fixed payment each month.
It’s also important to know that fixed-term mortgages usually come with an early repayment charge, which you’d be forced to pay to switch mortgages, before your existing mortgage deal ends. This may be a significant factor in your decision to switch or not. It may be worth waiting to remortgage until your existing deal is coming to an end, particularly if the early repayment charge is high. You will also need to factor in any fees and charges payable to secure a new deal.
Can a mortgage offer be withdrawn?
Yes, mortgage providers often reserve the right to withdraw a mortgage offer. Unfortunately, this could be at any time, including between contracts exchanging and completion.
If your potential lender does withdraw their mortgage offer, you’ll need to start the mortgage application process again. This potentially means another round of eligibility and affordability checks, with lenders reviewing your credit history and credit score to determine a new mortgage offer with potentially a different mortgage rate.
Need mortgage advice?
If you’re worried or confused about what’s happening with interest rates and how it affects your mortgage, you might want to speak to a mortgage advisor.
We’ve partnered with London & Country Mortgages Ltd (L&C)** to provide you with fee-free mortgage advice. Get in touch with one of their advisers here.
Go to L&C mortgagesAbout London & Country Mortgages Ltd (L&C)
**London & Country Mortgages Ltd (L&C) are a multi-award winning mortgage broker with over 20 years’ experience in helping people secure their perfect mortgage. Advice is provided by L&C, who are authorised and regulated by the Financial Conduct Authority (FCA) (143002).
L&C are not part of Compare the Market Limited. Compare the Market receive a % of the commission that our partner London & Country earns. All applications are subject to lending and eligibility criteria.
L&C will not charge you a mortgage broker fee should you decide to proceed with a mortgage.
What types of insurance might I need for a mortgage?
There are no legal requirements for insurance when getting a mortgage, but your lender will likely insist that you have at least buildings insurance, in order to protect their investment. If you’re becoming a joint homeowner, you might want to consider life insurance. With the right life insurance policy, you can protect your joint homeowner, financially, if you died before the mortgage is paid off.
What our expert says...
"Those soon coming to the end of their fixed rate deal are likely to face a big repayment shock, even if they’re remortgaging. It’s important to compare mortgage products online - checking the available deals and staying aware of what's happening in the market will help you to budget and save for the future."
- The Editorial Team, Experts in personal finance, insurance and utilities
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