Central banks set a short-term interest rate, the price at which banks lend to one another for very short periods. You do not borrow at that rate, but it influences almost everything you do borrow at.
Lenders look at that rate, at what they expect it to do in the coming years, and at how risky a borrower is. They add their own costs and profit. The result is the rate you are offered.
Fixed and variable
A variable-rate mortgage tends to move soon after the central bank changes its rate, and the monthly payment moves with it. A fixed-rate mortgage locks the rate for a set period, often two to five years; its price reflects what lenders expect rates to do over that period, not just today's level.
That is why fixed rates can rise or fall before the central bank has done anything: markets are guessing at the future.
What a change means for a payment
On a long loan, a small change in the rate has a large effect over time, because interest is charged on the remaining balance every month. When a fixed deal ends, the payment can step up or down at once. Checking the new rate before the old deal expires, and comparing lenders, is usually worth the time.
Key takeaways
- The central bank's rate is an input to your mortgage rate, not the rate itself.
- Fixed rates price in expectations; variable rates follow the central bank closely.
- A small change in rate matters a lot over a long loan, so compare before a deal ends.