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UK Mortgages Guide
Interest rates
Flaws of the Annual Percentage Rate measure
The average length of time people keep their mortgage for
is said to be around seven years. Whether it's because they
sell their house or opt for a remortgage, there are relatively
few people who keep exactly the same mortgage until it is
fully paid off. This means that comparing the total cost
of mortgage repayments over twenty-five years is not necessarily
all that realistic.
Using APR to compare mortgages flattens out some differences
that are more striking over a shorter period of time. Take
a look at this example:
There are two mortgages, A and B.
Mortgage A is extremely heavily discounted for five years.
After that, it reverts to a rate that is well over and
above the general level of rates in the market, as the
lender relies on you to stay loyal while they recoup the
cost of offering such an attractive discount.
Mortgage B is slightly discounted for three years, but
then reverts to a rate that is very competitive as standard
variable rates go.
Which mortgage do you choose?
If you compare solely based on APR, mortgage B is likely
to come out top, assuming that the other associated charges
are similar for both products. Over the twenty five years,
the competitive standard variable rate which is offered
for the bulk of the life of the loan will probably outweigh
the heavy early discount of mortgage A. However, if were
you change your mortgage after 7 years, you would probably
have been better off with mortgage A as you would have
been enjoying a strong discount for most of the time you
were making your repayments, while only going on to pay
the higher rate of interest for a short period of time.
Another point to bear in mind is that APR offers a snapshot
of what the average rate you pay over the life of the loan
would be if interest rates stayed the same for the whole term
of the mortgage. APR cannot make allowances for changes in
interest rate and the effect that will have on different mortgage
products. If rates change (as is almost certain) during the
discount, capped or fixed period, then the APR will instantly
become inaccurate. Consider this:
Two mortgages have exactly the same APR. One is a 5-year
fixed rate mortgage, the other is a base rate tracker. General
levels of interest rates rise and rise for the five years
after the mortgages are bought, then suddenly drop to their
original level and stay there for twenty years.
Looking back after twenty five years, the APR that was
originally quoted for the fixed rate mortgage will prove
to have been exactly right, since the rate payable remained
fixed throughout the period of rising interest rates. But
the total repayments and therefore the APR on the base rate
tracker mortgage would have ended up being higher than that
indicated at the outset, since payments would have increased
in line with interest rate rises over the first five years.
In reality the two mortgages that quoted the same APR could
have ended up with very different levels of overall repayments.
Although this exact scenario is never likely to happen,
it does highlight the fact that APR is not necessarily a perfect
measure of what your repayments are going to be.
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