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How are mortgage interest rates determined in the UK? Do you know the 2 major components?

Jak ustala się oprocentowanie kredytu hipotecznego w UK? Czy znasz 2 główne składowe?

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In times of high inflation, it makes sense to reduce unnecessary expenses, including those related to your real estate. What really affects the mortgage interest rates in the UK? What part of the installment is the interest rate responsible for, and what is the bank’s margin? In this article you will find the answers to these questions.

How are mortgage interest rates determined in UK?

What is the interest rate?

Let’s start with the basics. Although I wrote about interest rates at the time of their increase and encouraged you to read the Bank of England article, for today’s post I’ll go back to the definition for a moment.

Mortgage interest rate is nothing more than the money you pay to lender in return for borrowing from them to buy a property. The interest rate on loans that financial institutions make to each other is called the bank rate or reference rate. It applies to transactions, for example, between the Bank of England and commercial banks such as HSBCBarclays or TSB.

The interest rate on a loan, or APR, is affected by two main components: the bank rate and the lender’s margin. However, this does not mean that these are the only costs you will incur when you decide to make such a commitment. We will address these in a moment.

Bank rate

Now that you know what makes up a mortgage interest rates in the UK, it is time to analyse the main part of it. Currently (30 December 2022), the UK  bank rate  is 3.5% and this applies to all new mortgages and existing products which depends on BOE interest rates (also known as “Base Rate”).

It is important to remember that the vast majority of mortgages in the UK are fixed rate. The latest figures are for the second half of 2021, when only 26% of all mortgages were on a variable rate. This is just a speculation, but there is no indication that there will be any significant change in this area any time soon. If you want to know more statistics on the UK mortgage market, I encourage you to read the FCA’s report about it.

Bank’s margin

The second, and by far the more variable, component of a mortgage interest rate is the bank’s margin. This element of APR depends on a number of factors, including:

  • The purpose for which the property is being purchased. A Buy To Let mortgage will usually be more expensive than a personal loan on a variable rate (source: TSB)
  • It depends on whether it is a fixed or variable rate loan, because the bank has to compensate for the risk of rising interest rates.
  • Your credit score
  • Your own contribution. The bigger part of the property the bank has to finance, the higher the cost of the loan. The tables on HSBC’s website illustrate this very well.

As is not hard to see, mortgage interest rates in the UK are really influenced by many, often minor factors. However, a lot of these, such as your credit score, are up to you, so it’s worth paying attention to them a few months before you start the property-buying process.

Who influences the margin?

It is not uncommon to pay back a mortgage for up to 30 years, so it is really worth doing a lot to reduce the costs. For example, can you negotiate with your bank? As a general rule, mortgage interest rates in the UK are set by algorithms and there is little you can do about it. However, little does not mean nothing!

First and foremost, as I mentioned in the previous paragraph, it is worth taking care of your credit score by, for example, paying off outstanding fees. You should also consider raising at least a little more money for your own contribution, because the more you manage to save yourself, the more reliable a customer you are for the bank.  It is equally a good idea to be prepared for regular changes of lenders. After all, it is important to remember that banks’ offers can vary drastically and a current financial product that is very attractive to you at the moment may not be so attractive in two or three years’ time. Read more about this in our article on Remortgage.

Does a broker affect mortgage interest rates in the UK?

As brokers, we are unable to influence the bank rate or margin. However, we can help you choose an offer from among their larger base. Extend Finance is a so-called whole-of-market broker, so we are not limited to products from just one bank. This gives you, as our client, a broader view of the market and enables you to make decisions in an informed way.

The involvement of the broker is also important. According to the feedback from our clients (for which we thank you sincerely), as a smaller company we can really give each case a lot of attention, which results in satisfaction for both parties and the possibly low mortgage costs that fall on the borrower.

APR and APRC

When reading about both property-related financial products (mortgages) and credit cards, for example, you will quickly come across two quite similar terms – APR and APRC. What do they mean?

APR, meaning Annual Percentage Rate, is the cost of borrowing money over a year on a credit card or loan. It takes into account interest, as well as other charges you may have to pay, such as an annual fee. Example: if you borrowed £100,000 and the APR is 6%, the annual interest would be £6,000. (Source: What is APR and how does it work?)

APRC stands for Annual Percentage Rate of Charge. In simplest terms, it means the total cost, including commissions and fees. It is a reflection of the average expenses you will pay throughout the repayment period. The APRC can be thought of as the real mortgage interest rate in the UK. Why is it an indicator of average rather than annual expenditure? Because it is often the case that interest rates will be lower for a period of time, for example, to encourage borrowers to use a particular bank. This is a fairly new indicator introduced by the FCA in 2016, so it’s worth reading a bit about it, for example in this article.

Other expenses not included in mortgage interest rates

Unfortunately, interest rate is only part of your expenses. The costs of buying a flat or house in the UK should be described in a separate article, so I will only briefly list them this time:

  • Building condition report ( £450 to £1000)
  • Valuation fee (£0-£1500)
  • Product fee (up to £2,000)
  • Mortgage broker fee (average £500)
  • Stamp duty land tax, or transaction tax (find out the rates here)
  • Conveyancing, or legal fees (£800 to £1500)

I intentionally list these costs because they should not be forgotten when planning a purchase. Your mortgage may be at 6% interest, which will mean, for example, £12,000 of interest in the first year of repayment (based on property price of £200,000), while the purchase costs (listed above) could be approx. £5,000 depending on the type of product, property type, location and other factors. Of course, these are spread over many years, and you will usually only incur them once, but they are still a lot of money.

There really was a lot of information and figures in today’s article, but this was necessary to understand what UK mortgage interest rates are derived from. I hope you don’t find them discouraging. If you are planning to buy a property in the UK and are looking for a reliable adviser who can provide you with comprehensive answers to all your questions, I encourage you to get in touch with us. You can use the form in this link to do so.

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Think carefully about securing other debts against your home. Your home or property may be repossessed if you do not keep up repayments on your mortgage or any other debts secured on it.

Your Home (or property) may be repossessed if you do not keep up repayments on your mortgage or any other debts secured on it. Conveyancing services and some forms of Buy to Let mortgages are not regulated by the Financial Conduct Authority.

Your Home (or property) may be repossessed if you do not keep up repayments on your mortgage or any other debts
secured on it.

Your Home (or property) may be repossessed if you do not keep up repayments on your mortgage or any other debts secured on it. Conveyancing services are not regulated by the Financial Conduct Authority.

Extend Finance nor The Right Mortgage Limited can’t provide advice regarding Personal Pensions, Pension planning or investment planning advice. You must seek independent financial advice from a suitably qualified professional financial adviser who may charge you for advice.

Wills, Will writing, Trusts and Trust planning are not regulated by the Financial Conduct Authority.

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