Types of interest rates

Understanding interest rates

There are many different ways of calculating the interest. Click on each of the interest types to find out more.

Standard variable
This is the rate most borrowers pay. This goes up and down, depending on the Bank of England's base rate.

Fixed
This rate is fixed for a set period. During this time, your payments always stay the same, no matter if rates go up or down.

Tracker
With this rate, the amount you pay moves with the base rates. You usually pay a set per cent above the base rate for a set time or the full mortgage term.

Discount
These offer a reduction on a given interest rate, like 0.5per cent off the standard variable rate for a set period.

Capped
These rates won't rise above a certain level for a set period of time.

Standard variable
This is the rate most borrowers pay. If you have a discount, fixed rate or other low rate mortgage, which runs for a set time, you will normally be transferred to a standard variable rate when the introductory rate ends. This rate goes up and down, depending on the Bank of England's base rate.

Key pros and cons of standard variable rate mortgages

Pros

  • They are simple to understand.
  • The rate is variable - so you benefit from interest rate falls.
  • There are often no penalties if you switch from these types of mortgage rate.

Cons

  • You may get cheaper rates than the standard variable rate.
  • Because it's difficult to tell if interest rates will go up or down, it's hard to plan ahead.
  • The rate is variable-so if interest rates rise, your payments normally increase too.

Fixed
With a fixed-rate mortgage, you pay a set rate of interest for a set period, usually one to five years. During this time, you'll make the same monthly payments, whether interest rates go up or down.

Key pros and cons of fixed rate mortgages

Pros

  • Budgeting is easy. You know exactly how much you'll be paying and for how long.
  • If interest rates rise, your borrowing costs don't rise during the fixed-rate period.

Cons

  • If interest rates fall, you won't get the benefit of this.
  • You will usually have to pay a penalty if you want to switch to another mortgage rate before the end of the fixed term, and sometimes for a time after.
  • When the fixed rate ends, your borrowing costs could rise sharply as you will then normally pay the standard variable rate.

Tracker
With a tracker rate, the amount you pay moves automatically with the rises and falls in bank base rates. You usually pay a set percentage - for example 0.5 per cent - above the base rate for either a limited period (a few years) or the full term of the mortgage.

Key pros and cons of tracker rate mortgages

Pros

  • When interest rates fall, this cut is normally passed on to you in full. The only time you wouldn't benefit is if your tracker mortgage had a set minimum rate of interest and the base rate fell below this. You'd then be stuck paying the minimum interest rate agreed on your tracker mortgage at the start.
  • You are guaranteed never to pay more than a certain amount above the base rate.

    Cons

    • If interest rates rise, your payments will rise immediately, and by the full amount.
    • You may have to pay a penalty if you want to switch to another mortgage rate before the end of the tracker rate period and sometimes for a time after.
    • You may be able to get cheaper discount or fixed-rate mortgages.

    Discount
    A discount mortgage offers a reduction on a given interest rate. For example, it could be 0.5per cent off the lender's standard variable rate for a set period. If the standard variable rate changes, so does the discounted rate.

    Key pros and cons of discount rate mortgages

    Pros

    • The interest rates are less than the standard variable rate.
    • If interest rates fall, you'll get the benefit.

    Cons

    • After the discount period ends, you'll normally start to pay the lender's standard variable rate - so there may be a big increase in your monthly repayments.
    • You may have to pay a penalty if you want to switch to another mortgage before the discounted rate ends, and sometimes for a set period after.
    • The biggest discounts usually last for a very short period. For example, a 2.5per cent discount may be for six months only.
    • If interest rates rise, so does the discounted rate.

    Capped
    Capped rates won't rise above a certain level. This is set for the cap period, usually one or two years. For example, you may take out a capped rate mortgage at 5per cent, so you know that for the cap period this is the highest level of interest you will have to pay, even if interest rates climb to 7per cent, 8per cent or beyond.

    Key pros and cons of capped rate mortgages

    Pros

  • If interest rates fall, you still benefit.
  • Budgeting is easy. You know your payments will not rise above the capped rate.

    Cons

  • Initial rates may be higher than the cheapest fixed and discounted rates. This is a payback for the security you get with a capped rate.
  • You may have to pay a penalty if you want to switch to another mortgage before the capped rate ends, and sometimes for a set period after.
  • After the cap period ends, you'll normally start to pay the standard variable rate - so there may be a big increase in your monthly repayments.
  • The cap term doesn't normally last longer than two or three years.