Mortgage interest rates explained
"I don't know what a tracker mortgage is' is a well-known quote at this stage. But do you know the difference between the various types of mortgage rates on offer?
Before entering the mortgage market, you’re likely to have heard a lot of complicated terms thrown about the place and it can be easy to get lost among all the talk of APRCs, LTVs and such.
If you are getting ready to apply for a mortgage and are not sure where to start when it comes to interest rates, let this guide be your one-stop-shop mortgage interest rate glossary.
There are three main types of interest rate which will be discussed in this guide. Each type offers different advantages and disadvantages which you can learn more about here. The types are variable rate, fixed rate and split rate (which is a hybrid between the first two) and within these types there are a few different terms that you'll need to understand in order to choose the best mortgage rate for you.
What are variable rates?
As the name suggests, variable rates are subject to change, meaning that the interest rate can go up or down subject to a variety of factors.
Unpredictability might not be the most attractive option for those looking for stability but it’s important to know that variable rates offer the most flexibility. Variable rates allow you to top up, extend or pay extra off your mortgage without having to pay any penalties.
There are a few different types of variable rate to consider:
1. Standard variable rate
A standard variable rate is linked to the rates of the European Central Bank (ECB). This means that when the ECB rates rise or fall your lender can either raise or reduce your current rate in accordance. The changing of your rate is subject to the lender's discretion however and they are not obliged to change one way or the other. The lender’s costs and the level of competition in the market will be factors in whether your rate is increased or decreased.
2. Tracker variable rate
Similar to a standard variable rate, tracker variable rates are linked to the ECB. However, unlike standard variable rates, tracker variable rates are guaranteed to rise and fall in line with ECB rates. The rate is set at a fixed margin above the ECB rate so as ECB rates rise or fall, so does your rate with them.
Tracker mortgages were introduced in Ireland in the late 1990s and became extremely popular because they guaranteed customers the best possible mortgage rate. However, though customers are guaranteed a good deal, the lenders are not protected and after the recession many of them made little money on these mortgages. The result is that no providers offer tracker mortgages to new customers anymore.
3. Capped rate
A capped rate is exactly what it sounds like. Your rate is variable and can change but can’t go above a certain ‘cap’ or fixed rate, even if ECB rates rise. For instance, the cap could be set at a maximum rate of 7% for the first two years. The rate can rise up to that level but it cannot go above it, regardless of the current ECB rates.
4. Discounted rate
Discounted rates are temporary and are usually offered as incentives to new customers. Typically, the customer is offered a rate set below the standard variable rate for a predetermined period, usually a year. At the end of the period the customer can then switch over to a variable or fixed rate offer.
5. Loan-to-value (LTV) rate
LTV refers to the size of the mortgage compared to the value of the property you want to buy. For example, The Central Bank allows first-time buyers a maximum LTV of 90%. This means that a first-time buyer can apply to borrow 90% of the value of a home. So, if a first-time buyer wants to buy a property for €360,000 they can apply to borrow €324,000, making their LTV rate 90%. If your LTV is below a certain level some lenders may offer lower variable rates because the risk to them is lower, as the property is worth more than the amount needed to cover the mortgage.
What are fixed rates?
Fixed rates are a lot less complicated than variable rates but in turn are a lot more restricted. A fixed rate means that your interest and monthly repayments are fixed for a predetermined time, usually over one to 10 years; however fixed rates as long as 30 years are now available in Ireland.
A fixed rate offers peace of mind and certainty because it means that your rate definitely won’t go up in that time. Unfortunately, your rate also definitely won’t go down, which means you might miss out on lower interest rates and lower repayments.
It’s also important to note that there are a lot of fee penalties associated with fixed-rate mortgages. You will usually be subject to penalties if you decide to move to a variable rate, if you want to switch lenders, re-mortgage or pay off all or part of your mortgage early. Additionally, you should be aware that paying more each month than your standard repayment is usually not allowed on a fixed rate contract - though some lenders now allow this.
What are split rates?
Split rates offer customers the benefits of both a variable rate and a fixed rate as a split rate is a combination of the two. Your mortgage is split into two portions where one portion is on a fixed rate and the other on a variable rate.
Which rate type is best for you?
Now that we are more familiar with rate types, considering the advantages and disadvantages of each is the next important step in determining what the best fit is for your mortgage needs. If you want to learn more about these advantages and disadvantages of fixed versus variable rates, you can find all the info you need to know here.
Before you decide, always compare!
Taking out a mortgage can be a very stressful and nerve-wracking time. Choosing a fixed rate or a variable rate is one of a number key decisions you’ll make when buying a home and it’s important to have all of the information available before committing.
You can compare fixed rates and variable rates on bonkers.ie now