Interest rates are probably the most important part about buying a house.

Standard variable rate
This is the general rate of interest that lenders use and it's usually the most expensive option for the borrower. The standard variable rate is linked to the Bank of England's base rate and moves up and down in line with it, and a typical rate at the moment is about 1% to 2% higher than the base rate. So whenever you hear that the Bank of England has raised or cut interest rates by a quarter of a percentage point, you'll know your mortgage rate is probably about to go up or down by a similar amount.

If you're on this sort of standard rate, you'll probably notice that lenders like to introduce any increase with effect immediately and to delay any cuts by a month or two. At any rate, it's never going to be the cheapest deal on the market so if you find yourself landed with it, be aware that you're effectively subsidising all the other borrowers who are taking advantage of any cut-price special offers! However, note that most special offer deals will revert to a standard variable rate once the offer period has expired.

Fixed rates
This is exactly what it says. The rate of interest is fixed for a certain length of time, so you'll know exactly how much you'll need to find each month to pay the mortgage. The fixed rate is great for people who are a little stretched financially and need to know where they stand from pay cheque to pay cheque. They're also good value if interest rates look set to rise in the early years of a mortgage, although bear in mind that the mortgage providers are likely to be one step ahead of you and adjust their fixed rates accordingly. However, a fixed rate also means you could end up paying more than everyone else if general interest rates fall below the figure you've set yours at. But that's the risk you take in exchange for having certainty about how much you will pay each month.

Discounted rates
This is simply a percentage discount off the lender's variable rate. So your monthly payments will move up and down in accordance with the lender's normal rate but you'll be paying at a reduced rate over the relevant time period. These can be good for first-time buyers as a discounted mortgage can give you a couple of years of breathing space. A 1% or 2% discount is especially good if there's no lock-in period afterwards because you could simply re-mortgage with another lender when the discount period comes to an end. Unfortunately, you'll often find you're locked in for another couple of years on the variable rate, so you won't be able to get out of this sort of deal unless you're prepared to pay potentially significant redemption penalties.

Tracker rates
A tracker mortgage is a variation on a standard variable rate. With a tracker mortgage the difference between the Bank of England base rate and your mortgage rate is fixed. For example, your mortgage might be set at 1% above the base rate. Although standard variable rates closely follow the base rate, they are not formally linked to it. So if you want to ensure a cut in the base rate is always passed onto you in the form of a lower mortgage rate then a tracker could be for you. Of course, the flip side is that any rise in the base rate is also passed on straight away.

Tracker rates usually apply for the entire duration of your mortgage, so in that respect they differ from fixed, discounted and other special rate deals which tend to only apply for the first few years.

Capped rates
These ensure that there is a ceiling to the interest rate you will pay over a given period of time. If your lender's variable rate climbs higher than the capped rate you will benefit. But if it falls below the capped rate you'll just be paying what everyone else is paying.

Capped rates tie you in to the mortgage for a set period of time, similar to fixed rates. Capped rates give you part of the advantages of fixed rates and of variable rates. Again, you'll have to give something back for this. For example, the capped rate is likely to be higher than any fixed rate you can get. Like fixed rates, they make good sense for those on tight budgets who need to ensure that their monthly payments don't rise too far.

How is the interest charged?
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 could pay 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 still 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 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 need 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 may 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 manoeuvre, 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 such a 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.

Your home may be repossessed if you do not keep up repayments on your mortgage.
Article date: 10.06