How To Calculate Mortgage Interest

What are mortgage interest rates?

Your mortgage interest rate determines how much you’ll be charged by your lender to borrow the funds needed to buy your home. It’s calculated as a percentage of your mortgage’s balance and will affect your monthly repayments.

Mortgage interest rates impact how much your loan balance will grow every month. The higher the interest rate, the higher your monthly mortgage repayments.

How does mortgage interest work?

When you take out a mortgage, you pay back the loan balance plus whatever additional interest you’ve agreed with your mortgage provider. This is how mortgage lenders profit from the money they lend. In other words, the interest is a fee you’re charged to borrow the mortgage amount.

Interest-only mortgages vs repayment mortgages

An interest-only mortgage means you only pay off the interest and not the loan itself. If you have a repayment mortgage instead - the most common type - you’ll pay a set amount of your loan balance back each month, plus interest.

What are the different types of interest-rate mortgages?

There are three main types of mortgages - fixed, variable and tracker. Read on to find out more about each.

1. Fixed-rate mortgages

For fixed-rate mortgages, the interest rate and how much interest you pay stay the same for however long you’ve chosen to fix your rate. This can be between two and 10 years, depending on what your lender offers. Whatever the market rate was when you first took out your mortgage, that’ll determine the rate the interest will stay at - regardless of whether market interest rates go up or down during the fixed term. For this reason, the longer the length of time you fix for, the less competitive a rate you’ll usually get. The lender is taking a bigger risk offering these deals when the market might rate rise during this time.

When your fixed term ends, you’ll move onto a standard variable rate (SVR) unless you decide to remortgage and find a new mortgage deal. This SVR is likely to be higher than your fixed rate was. So most people shop around for a new mortgage deal two to three months before their fixed rate ends to try and keep their monthly repayments down.

• Pros: Reassurance that your monthly mortgage repayments will stay the same makes it easier to budget.

• Cons: Fixed-rate deals are usually slightly higher than variable-rate mortgages (see below). And if market interest rates fall, you won’t benefit.

2. Variable-rate mortgages

Variable-rate mortgages roughly follow the Bank of England’s base rate. But ultimately, the interest rates are chosen by the lender. The interest rate can go up or down anytime. Most initial deals will be at a discount from the lender’s SVR.

• Pros: Variable-rate mortgages typically have slightly lower interest rates than fixed-rate deals. And if market interest rates fall, you’ll benefit from smaller monthly repayments.

• Cons: Interest rates can fluctuate, making it difficult to budget and know what your monthly repayments will be. If market interest rates go up, so will your monthly repayments.

3. Tracker-rate mortgages

Tracker-rate mortgages work similarly to variable-rate mortgages. They’re generally linked to or ‘tracked’ against the Bank of England’s base rate. However, the difference with a tracker-rate mortgage is that the interest rate is set at a fixed amount above or below the tracked rate.

For example, if the base rate is set at 0.6%, you might have a tracker rate set at 1% above this - so you’ll pay 1.6% interest on your mortgage.

• Pros: If the tracked rate falls, so will your mortgage repayments.

• Cons: If the tracked rate rises, so will your mortgage repayments. It’s also harder to budget as your interest rate can vary.

How do mortgage lenders set interest rates?

The exact interest rate you’ll pay on your mortgage is based on many factors, including:

• The Bank of England’s base rate

• Where the mortgage lender gets the money they lend to you, and how much it costs them (e.g. from savings deposits from existing customers or by borrowing themselves)

• Your credit history and credit score

• The risk to the mortgage lender - in other words, how likely they think you’re going to be able to keep up repayments

• The mortgage lender’s business targets and competition within the market

How to calculate your mortgage interest

Want to work out how much mortgage interest you’ll pay? Follow the simple steps below:

• Step 1 - Take the current outstanding balance owed on your mortgage.

• Step 2 - Multiply that number by your current interest rate as a decimal.

• Step 3 - Divide that number by 12.

This will give you the amount due in interest on your next mortgage repayment.

For example, say you have £250,000 left of your mortgage still to pay, and the current interest rate for your mortgage deal is 2%. You multiply 250,000 by 0.02, which is 5,000. Then, divide that by 12, and you get 416.67. So you’ll pay £416.67 interest on your mortgage on your next monthly repayment.

How much interest do you pay on the whole mortgage?

Calculating how much interest you’ll pay over your full mortgage term is much trickier because you don’t know what interest rates will be in the future. You’ll likely switch to different mortgage interest rates or deals every few years. The amount of interest you’ll pay will also depend on how quickly you pay off the balance.

However, if you want an estimate, you can ask your mortgage lender to give you a breakdown of your interest based on you staying on your initial rate and paying at the same speed (e.g. not making any over-payments) throughout your mortgage term.

Let’s find your new home today

Buying your home with Purplebricks is simple. Book your free house valuation, book viewings easily online, and message sellers directly through our app. Got a question? Our team of experts are here to help you every step of the way - get in touch today.