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HOW TO: UNDERSTAND INTEREST RATES

HOW TO: UNDERSTAND INTEREST RATES

Interest rates are something most of us pay no attention to, until we take out a mortgage or other loan, at which point it becomes very important to understand how they impact on repayments.
 
Here are some key pieces of information you might need to know about interest rates before approaching a lender and taking out your first home loan.
 
What are interest rates?

Interest rates are the amount a lender charges to a borrower for lending them money. When you leave your money in a bank account, you are effectively lending the bank your money and the bank will pay you interest at an agreed rate for doing so.
 
When a bank, or another lender, lends you money in the form of a mortgage to buy a home, you are obliged to pay that money back over a period of time, plus interest at the agreed rate.
 
Calculating mortgage interest rates

The interest rate you will pay is worked out as a percentage of your mortgage. If, for example, the interest rate is 4% on a £100,000 loan, you must pay back the loan itself, plus an additional £4,000.
 
When shopping around for a mortgage, it is crucial to consider the rate of interest you will have to pay back. You can calculate this on a daily, monthly, quarterly or annual basis.
 
The amount of interest you will pay is based on your outstanding balance. If you pay off some of your balance each month, this will ultimately benefit you in the long run by bringing down the amount you owe.
 
Look beyond introductory offers

In order to win your business, some mortgage companies may offer you an initial introductory rate for a short period of time, after which point the interest rises. Lee Cardwell, from Mortgage Bureau, an independent mortgage advisor to Strata customers, recommends you think about a home loan in the long term.
 
"Interest rates are key when deciding on a mortgage, but borrowers need to look at the overall package, rather than just the headline rate. They should weigh up the best overall cost throughout the duration of the deal," says Lee.
 
"When remortgaging further down the line, interest rates may have increased, so it’s important to weigh up the various options."
 
Be aware of changing interest rates

If you have a fixed-rate mortgage, the interest rate you pay will remain the same for the fixed-rate period. After this time the rate could rise, at which point it’s worth seeing whether it is possible to find a more competitive deal with another lender - or even your existing one.
 
If you have a tracker mortgage, this mirrors the Bank of England base rate and the interest rate you pay will be a set percentage above this level. So, if the base rate increases, your interest payments will rise, but it if the base rate is reduced, they will fall.
 
Reduce how much interest you pay

The bigger the deposit you can put down on your home, the greater your eligibility for the lowest mortgage rates. Choosing a shorter term mortgage, of say 20 years instead of 25 years, could also mean you can access more favourable interest rates.
 
You can also reduce the rate by overpaying your monthly instalment, if your lender allows you to do this without a penalty. Once your mortgage comes to the end of its fixed term, remember to always shop around to see if you can remortgage at a lower rate. 

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