How are mortgage rates set?

When you look for a mortgage, one of the most important decisions is choosing the type of interest rate.

Your mortgage's interest rate will affect how much your mortgage costs you each month: the higher the interest, the more you have to pay.

The rate can be set in several different ways. Some are guaranteed to stay the same for a number of years, some can change at any time and others move up and down if either of these rates change:

  • The Bank of England base rate is how much the Bank of England charges to lend money to banks and building societies. Lenders use this as a reference for some of their own interest rates, which will go up or down when the base rate changes.

  • The lender's standard variable rate (SVR), which is the interest rate they put you on after your mortgage deal ends. Lenders have one SVR for all their borrowers and can change it whenever they like.

What types of interest rate can you get?

Fixed rates

Their interest rates will not change for a set period of one, two, three, five or ten years.

This means that the amount you pay each month will stay the same until the deal ends. Even if the lender's SVR or the Bank of England base rate goes up, you will pay the same amount until the end of the fixed term.

When your fixed rate finishes you will be charged the lender's SVR instead, unless you move to a new mortgage deal at that point.

For example: You take out a mortgage fixed at 4% for five years and the Bank of England base rate goes up after a year. You will carry on paying the same amount for another four years.

  • Rate is fixed

  • Repayments stay the same

  • Most expensive rates and fees

  • Will not drop with base rate

Standard variable rates

Their interest rates can go up or down whenever the lender decides. When the rate goes up, your monthly payments will increase; if the rate falls, your repayments will go down.

Their rates loosely follow any changes in the Bank of England base rate, but they do not have to copy its changes exactly. This means the country's economy can affect how much your mortgage costs you each month.

For example: You take out a variable mortgage at 2.5% and the Bank of England base rate later goes up by 0.75%. Your lender then increases your rate by 1% to 3.5% and you pay more each month.

  • Can be cheaper than fixed deals

  • Usually no early repayment charge

  • Rates can rise at any time

  • No guarantee rates will ever drop

Tracker rates

Their rates are variable and go up or down every time an economic index like the Bank of England base rate does. Your interest rate will change by the same amount.

For example: You take out a mortgage that tracks at 2% above the Bank of England base rate. The base rate is 0.5% at the start, so you pay 2.5% interest. When the base rate goes up by 0.75% to 1.25%, your mortgage rate would change to 3.25%.

Their interest rates usually last a set number of years. After this period ends you will be moved to the lender's SVR, which is often higher. However, some lifetime tracker deals offer tracker interest rates for the entire term of your mortgage.

  • Your interest rate could fall

  • Deals can last for several years

  • If base rates rise, yours will too

  • Could charge high rates for years

Discount rates

Their interest rates are variable and offer a discount on the lender's SVR. This means they will be a set amount below the SVR and will go up and down whenever it changes (and will change by the same amount).

The discount is usually around one or two percent less than the lender's standard variable rate and will last for a set period of a year or more.

For example: You take out a mortgage with a 2% discount. The SVR is 5% at first, so you pay 3%. After a year, the lender raises its SVR to 6%, so your new interest rate is 4% and your monthly payments increase.

  • If SVR falls, your rate goes down

  • Rates are lower than SVR

  • SVR can increase any time

  • No guarantee SVR will ever drop

Capped rates

These can be a type of mortgage with a:

  • Variable interest rate

  • Tracker interest rate

  • Discount interest rate

Although their interest rates can go up or down with the base rate or your lender's SVR, they come with a guarantee that they will not rise above a certain amount.

For example: You take out a mortgage with a 1% discount and a cap at 4.5%. The SVR is 5% at first, so you pay 4%. After a year, the lender raises its SVR to 6%, so your new interest rate would change to 5%. However, the cap means you only pay 4.5%.

  • If rates fall, your rate goes down

  • You are protected from large rises

  • Their rates start higher than most

  • The cap is usually quite a high rate

How much do they cost?

Mortgages come with several charges and fees, but the interest you pay will be the highest cost.

This guide explains how interest and the other costs of a mortgage are worked out.

Which mortgage type is cheapest?

Choosing a mortgage with the right kind of interest rate can save you thousands, but the cheapest option over the long term will depend on if the Bank of England Base rate goes up or down:

  • If interest rates go up, fixed rates are usually best because your mortgage rate and repayments would be guaranteed to stay the same

  • If interest rates go down, variable, tracker or discount rates are usually best because their rates will fall and you would pay less (but a fixed rate would not change)

  • If interest rates stay the same, variable, tracker or discount rates are usually best because they often start with lower interest rates and less fees than fixed mortgages

However, the base rate rises and falls based on factors that are very hard to predict like inflation, unemployment and the Bank of England's confidence in the strength of the UK's economy.

How much will it cost if rates rise?

  • if you had a 150,000 mortgage with a fixed rate of 3.07%, your monthly repayment could be 731.18

  • If you took out a 150,000 mortgage that tracked 2% above the base rate, your monthly repayment could be 664.94 at first, but could rise to 763.79 if the base rate increased by 1%

How much will it cost if rates fall?

  • if you had a 150,000 mortgage with a fixed rate of 3.07%, your monthly repayment could be 731.18

  • If you took out a 150,000 mortgage that tracked 2% above the base rate, your monthly repayment could be 664.94 at first, but could fall to 620.78 if the base rate fell by 0.25%

Which type should you get?

Predicting if interest rates will rise or fall is extremely difficult, so it makes more sense to base it on your financial situation:

  • If you can afford the risk of rates going up and can easily afford your mortgage repayments, a variable, discount or tracker rate could give you a lower starting rate and a chance that it might work out cheaper overall

  • If you could not afford higher repayments if rates go up, getting a fixed rate mortgage means you will keep paying the same amount for the fixed term

Decide on a long or short term deal

If you get a fixed, tracker, discount or capped mortgage you will have to decide on how long you want the initial interest period to last.

With a fixed mortgage the rate this will be a guaranteed interest rate. Tracker, discount and capped mortgages will follow the Bank of England Base rate or the lender's SVR for this period. You can usually get deals that last for one to ten years.

When will you move house?

If you expect to move house soon, you may have to pay early repayment fees if you are still in your mortgage's introductory or fixed rate.

A variable rate is less likely to charge these fees, but some fixed rates are portable, which means you can keep the same mortgage to buy your new property.

How to get a mortgage

You can apply for your mortgage through the lender once you have found the one you want. Here is how to decide which mortgage is right for you.

You can use our comparison tables to find the type of mortgage you want:

If you want help and advice to get the right kind of mortgage, you can use a mortgage broker or independent financial adviser.