Borrowing guide - interest rates

Generally speaking, UK interest rates that banks offer borrowers relate closely to the central bank's interest rates. The central bank in the UK is the Bank of England and it varies interest rates in response to, or to manipulate, economic conditions.

Therefore, banks normally include in their terms and conditions that they may vary their interest rates in line with the Bank of England, i.e if the Bank of England raises its interest rates by 0.25%, so will the lending banks. Of course, if the Bank of England lowers its rates, the lending banks will do the same.

This is a normal condition of a loan, as opposed to a special condition, and is known as tracking interest rates.

Clearly, increased interest rates mean increased monthly repayments and can be a source of anxiety for the borrower. In response to this, the banks have two options that they will offer borrowers who do not want to take on this risk:

Fixed rate - the bank will agree a rate at the beginning of the loan term which will apply throughout the term of the loan.

Capped rate - this is where the lending rate will track (up or down), up to a maximum or 'capped rate'. If the tracking rise above the capped rate, the bank will assume the loss.

In both of these cases, the bank assumes most of the risk associated with fluctuating interest rates. They offset this risk by a slight increase in the nominal interest rate.

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