The Relationship Between Bank Rates and Mortgage Rates Explained

The Bank Rate was just 0.1% in December 2021. However, it now stands at 5.25% following 14 consecutive hikes by the Bank of England. This dramatic rise has many people concerned about what it means for their finances, especially mortgage holders. Unfortunately, some mortgage holders don’t fully understand the relationship between the Bank Rate and mortgage interest rates, further adding to the panic and confusion.

Here is a comprehensive guide on the relationship between the Bank Rate and mortgage rates. The guide also covers the various types of mortgages.

What is the Bank Rate & How Does it Affect Mortgage Rates

The Bank of England refers to the Bank Rate as the UK’s most important interest rate. To this end, the rate determines how much people earn on savings or pay on loans, including mortgages. The Bank of England Monetary Policy Committee (MPC) updates the Bank Rate ten times per year, hiking, lowering, or holding it based on the current inflation rate.

The MPC hikes the Bank Rate to make borrowing and spending money expensive when inflation goes up. To this end, an increase in the Bank Rate can mean an increase in your mortgage interest rate and monthly payments, while a decrease means the opposite. However, it only affects variable mortgages because their rates are subject to change. Fortunately, fixed-rate mortgages are immune until the fixed period expires.

Types of Mortgage Interest Rates

Mortgages are categorized into two types based on the type of interest rate offered. Here is an overview of the various mortgage types:

Fixed-Rate Mortgage

A fixed-rate mortgage has a fixed interest rate that doesn’t change even when the Bank Rate changes. To this end, your monthly payments remain the same for the agreed period even when the Bank Rate increases.

Lenders usually offer fixed-rate mortgages for periods ranging from one to five years, but some can offer longer-term agreements for periods up to ten years. Notably, the fixed-rate mortgage turns into a standard variable rate (SVR) mortgage when the agreed period expires, making it vulnerable to Bank Rate fluctuations.

Variable-Rate Mortgage

Variable-rate mortgages have variable interest rates that change when the Bank Rate changes. On the one hand, your monthly payments increase when the Bank Rate rises. On the other hand, the monthly payments fall when the Bank Rate falls.

Interestingly, variable mortgage rates come in the following six types with varying policies:

·         Interest-Only Mortgage

An interest-only mortgage requires you to make monthly payments only on the mortgage’s interest – essentially, the monthly payments exclude the principal. However, you must also pay the full principal amount when making the last interest-only monthly payment.

To this end, the monthly payments are considerably lower than with ordinary mortgages. However, the final payment on the mortgage’s principal can be considerably large.

·         Standard Variable Rate (SVR) Mortgage

A standard variable rate (SVR) mortgage gives the lender the power to increase or reduce the interest rate as they see fit. To this end, your monthly payments can increase or decrease unpredictably. However, interest rate changes are mostly based on Bank Rate changes. Interestingly, you can overpay or leave the agreement without penalties.

·         Tracker Mortgage

Tracker mortgages are based on another interest rate, usually the Bank Rate. Essentially, the lender tracks changes in the Bank Rate and adjusts their mortgage rates by the same margin. For example, the lender increases the mortgage rate by 1% if the BOE hikes the Bank Rate by 1%.

·         Discount Rate Mortgage

A discount rate mortgage comes with a lower (discounted) rate than the lender’s standard variable rate (SVR). To this end, your monthly payments are lower than they should be, saving you some money. However, the discounted rate only lasts for a limited period, usually two to five years, after which the SVR applies.

·         Capped-Rate Mortgage

A capped-rate mortgage usually comes with a limit on how high or low the standard variable rate can go, despite changes in the Bank Rate. To this end, this mortgage type protects you against high Bank Rate hikes. However, it is worth noting that capped-rate mortgages usually have higher interest rates than SVR mortgages.

·         Offset Mortgage

An offset mortgage allows borrowers to link their mortgages to their savings accounts. Moreover, the lender deducts the amount in the savings account from the mortgage and limits interest payments to the difference. For example, if the mortgage is worth £100,000 and the savings account has £50,000, you only pay interest on £50,000.

Wrapping Up

A rise or fall in the Bank Rate can increase or decrease your mortgage’s interest rate, depending on the type. Overall, fixed-rate mortgages are immune to Bank Rate fluctuations, but variable-rate mortgages are not.