The interest homeowners pay each month is closely linked to what the Bank of England is doing. Every month the Bank of England looks at the economy, especially the inflation rate, and decides whether to fine-tune the financial position of the economy by raising or lowering interest rates.
If they feel the economy is flagging and needs a boost, they may lower their base rate to make it easier for businesses to afford to borrow money. If they think the economy is overheating and people are spending too much, then they may raise the base rate to persuade people to stop running up debts and start saving.
The Bank of England base rate is the figure around which loan interest is calculated. If the base rate goes up, commercial mortgage lenders will generally put their rates up as well. It’s a bit like the way an increase in the oil price in the financial markets filters through as an increase in the petrol price at the pumps.
The interest rate is the major factor in the amount you pay. But how interest is calculated can have a substantial effect on the overall cost. With many standard mortgage products, the interest is calculated on an annual basis. This means that even if you pay off a lump of your mortgage during the year, the reduction won’t take effect for the purpose of calculating interest until the end of the accounting year. Flexible products, on the other hand, calculate interest on a daily basis. This means that any repayments you make have an immediate effect on interest. Over the length of the term, this can be an important benefit. (‘APR’, discussed below, can show you graphically how these different deals compare in real terms.)
The higher the proportion of the purchase price you borrow, the higher the interest rate you will be charged by some lenders.