Mortgages: Mortgage Interest Rates

Having looked at the various ways you can repay the capital amount of your mortgage, we now turn our attention to the interest element.

Interest rates are probably the most important part about buying a house. After all, your aim is borrow the money you need for the least possible cost, so you need to assess which type of interest rate is best for your particular circumstances.

How is the interest charged on mortgages?

Regardless of the type of interest rate you go for, one vital question to ask is how frequently interest is calculated. If you opt for a mortgage on which the interest is calculated daily (sometimes referred to as an Australian mortgage) you'll pay much less interest over time because every payment immediately reduces the amount you owe. Where the interest is calculated monthly, you might end up waiting a whole month after making a payment before the interest is recalculated -- so you end up paying interest on money you don't actually owe any more!

But some lenders are sneakier still. They calculate the interest payable on the amount due at the start of the year and this can add several pounds to the typical monthly mortgage payment. It also means that if you make an additional payment to reduce your mortgage it could be up to a year before this reduces the amount of interest you are charged.

Which type of mortgage is best?

As you might expect, there is no simple answer to this question. Most people will obviously want the cheapest deal they can get. But you may to compromise a little on cost in order to get something that is a little more flexible. For example, the very cheapest deals may have penalties attached for a few years after their special rate expires. In such cases, you could end up paying more overall, as you could be stuck on an expensive standard variable rate for some time.

Fixed-rate deals are often the most popular choices. If you're on a tight budget then they are usually the best choice. If you have a little more room to play, a discount deal or a tracker might suit you better. Capped deals are a good idea in practice but often tend to be quite expensive with the capped rate set at a such level that it's rarely necessary in practice.

When comparing mortgages, it's best to compare the monthly amount you're quoted rather than comparing various interest rates on offer (the latter should be expressed as an Annual Percentage Rate, or APR). There are a number of different ways APRs can be calculated so two mortgages that charges ostensibly the same rate of interest could result in two different monthly payments. However, when you compare costs in this way make sure you also take into account upfront costs like the mortgage application fee.

Find out more about:

• Fixed rates
• Discount rates
• Tracker rates
• Capped rates

Next article: Extra Mortgage Costs

Published on November 22, 2006