Understanding Interest Rates

How Interest Rates are Charged

There is a common belief that the interest rate is simply the amount of profit accrued to the lender. This is, of course, not the case. The fact is that each year the adjusted calculation for actual cost-of-living tends to rise. In moderate fiscal circumstances, this may be in the region, as is currently the case, of between 3% to 6%.

Put simply, this means that the pound that was borrowed a year ago becomes now 3% to 6% reduced in spending value. A more obvious example of this monetary fluctuation is that a house which would have been valued at £50,000 25 years ago, may now have reached a peak valuation of £250,000 on the current market.

The interest rates, regulated by the Bank of England base rate which comes under monthly review, are part of the checks and balances put in place to ensure that the lender recoups the full value of the loan, plus of course the essential profit which incentivises the actual business of lending. Therefore mortgage interest rates are inevitably slightly higher than the Bank of England base rate, ensuring the lender profits on the risk taken.

It must also be borne in mind that in times of very high inflation, such as those which existed in the 1970s, interest rates can become very high indeed, soaring to around 17% in November 1979. It is therefore essential that the borrower is aware of the monetary climate at the time the mortgage enquiry takes place.

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