Interest rate options

There are many different interest rate options, and further variations are continually being introduced. Often you may find rates changing frequently on special offers but the main types are:

Variable rate

The most straightforward interest option is the variable rate. The interest rate charged will change from time to time in line with market conditions. In some cases monthly repayments will be altered as soon as interest rates change, while in others any such change once per year.

Fixed rate

In this case the interest rate is fixed at outset, usually for a prescribed period at the start of the mortgage. Rates available vary from time to time and reflect not only current market conditions but also future expectations of interest rate movements. The fixed rate mortgage does however provide a borrower with the opportunity to lock into rates that are broadly current, giving certainty of repayment levels and protection from future increases in rates.

If interest rates fall, however, the fixed rate will not, and the lender is likely to charge a redemption penalty if the borrower wishes to move his mortgage to another provider.

Discounted rate

A discounted rate mortgage is one where the interest for an initial period of the loan, commonly one or two years, is charged at a lower rate than that which would normally apply. This is usually expressed as a reduction from the normal variable rate. This type of loan can be useful for borrowers who need to minimise outgoings in the early stages of the mortgage.

Capped and collared rates

This is a method of limiting interest rate fluctuations without fixing them entirely. As a result the borrower achieves reasonable certainty of the level of repayment required, but is still likely to be subject to redemption penalties as would be the case with a fixed rate mortgage, if you chose to switch to another lender. A capped rate loan specifies the maximum interest rate that could apply, while a collared rate is the minimum rate that could apply. It is possible to arrange a mortgage with either a capped rate or a collared rate, or with both.

Cashback loans

Although not strictly an interest rate option, it is reasonable for cashback loans to be considered here.

As an incentive to choose a particular lender either for a new loan on moving house or for replacement of an existing loan, the borrower receives a cash bonus at the time the loan is completed. The amount is generally expressed as a percentage of the amount of the loan.

Although at one time the Inland Revenue maintained that cashback payments would be subject to CGT, this ruling has now been withdrawn. Thus, these payments should now be tax free.

Conditions

Where a loan is granted on terms other than a straightforward variable rate, there are often special terms attached. For example, a discounted rate will usually require the borrower to remain with the lender for a minimum period of perhaps three to five years. Similarly, a fixed rate mortgage is likely to involve penalties if the loan is repaid early. Always double check if penalties apply and what effect this may have on your future plans.

Practical points

Many lenders attract new borrowers by offering special terms for new mortgages. These can include cashbacks or reduced interest rates for an initial period, and can be advantageous.Generally, the borrower will then be tied to the new lender for a specific period, so the terms offered overall need to be carefully examined. Any costs associated with the mortgage, for example legal and survey costs, also need to be considered.