Warnings over sharp rise in mortgage interest rates

The more you have borrowed, the less likely it is that you will be able to cope with higher costs.

So how can you plan for rising rates?

The borrowing boom

Rising house prices and record low interest rates lately have encouraged buyers to borrow as much as possible to secure a deal.

Nearly 8,400 mortgages were approved for borrowers with less than a 10 per cent deposit in June, the highest monthly total since before the pandemic, according to data obtained from the Financial Conduct Authority (FCA), the City regulator, under a freedom of information request.

Between April and June, 13.62 per cent of single homebuyers took out loans of at least four times their income.

Some 44 per cent of loans taken out by couples were for at least three times their joint income. And 57 per cent of all mortgages were defined as “large” between April and June (at least three times income for couples, four times for single borrowers). Large loans make up the highest proportion of lending since comparable records began in 2007. A year ago less than 50 per cent of loans were classed as large.

While most borrowers will have fixed their loan interest, which should shield them from a rise in the base rate, they could find that mortgage costs soar when they reach the end of their term.

Who suffers if rates soar?

First-time buyers are most exposed to a rate rise because they tend to have the lowest amount of equity in proportion to the value of their home. They are also worst affected when house prices fall, because this high loan-to-value (LTV) makes them most at risk of falling into negative equity.

That is why high LTV mortgages were first to be whipped away by lenders when the pandemic hit.

All leading lenders stopped offering loans to borrowers that had only a 5 per cent deposit.

They shifted their focus to wealthier homeowners amid fears that house price falls would leave owners in negative equity. This pushed rates for borrowers with large amounts of equity to record lows of below 1 per cent, but many of the big banks and five building societies have increased the cost of mortgages in the past week.

It is important to remember that you will only pay more when a fixed deal ends. But if the guidance from the Bank of England and predictions from other economists are right, it seems unlikely that today’s record low rates will hang around.

Even with recent increases, rates are still not as high as they were one year, or even six months, ago, but the boom in small deposit mortgages means that this can be a concern, particularly if rates continue rising.

One thing you can do today is think about overpaying your mortgage now. Even a small amount every month can make a dent over the long term, reducing the amount that you will need to borrow when you next come to remortgage. This should help you to get as low a rate as possible.

If you are coming to the end of a deal today, think carefully how long you would like to fix your rate for.

If you have no plans to move home, then it may be worth taking out a five-year fix, which will protect you from future rate rises and give you the greater financial stability of knowing exactly how much you will have to pay each month.

In anticipation of rising inflation, mortgage rates have started to rise for those borrowers with large amounts of equity who have been getting rock bottom deals.

Those with smaller deposits, however, are finally getting a better deal.

The average two-year fixed rate at 95 per cent LTV was down to 3.22 per cent on November 1 from 3.32 per cent a month earlier and an average of more than 4 per cent in 2020.

The average two-year fix at 90 per cent LTV is down from 2.65 to 2.54 per cent, according to Moneyfacts, the data firm.

Buying a £300,000 property with a 5 per cent deposit at the market-leading two-year fix of 2.45 per cent with a £1,339 fee from Newcastle Building Society would cost £76 a month less than the best rate of 2.59 per cent last September.

But a mortgage on the same property with a 40 per cent deposit would now cost £15 a month more than a year ago because the cheapest deal has gone from Platform’s 0.88 per cent with a £1,114 fee to HSBC’s 0.99 per cent with a £1,129 fee.

“Lenders are raising their cheapest mortgage rates first, so those needing a high loan-to-value have not suffered an equivalent rise in costs compared with wealthier borrowers,” said Mark Harris from the mortgage broker SPF Private Clients.

“That said, they were paying proportionately more than those with bigger deposits in the first place, because they are seen as higher risk, so arguably they can least afford a rate increase.”

Q&A

In the past 14 years there have been only two base rate rises, so there is a whole generation of homebuyers who have never experienced the pain of watching rates steadily increase. The next few months could come as a shock.

What can we expect?

The Bank of England’s monetary policy committee meets again on Thursday, December 16 to decide whether to put up the base rate.

When it rises you can expect banks to raise their standard variable rate (SVR), the rate your mortgage moves to at the end of a fixed or tracker deal. You can normally rely on the full increase to be passed on, although banks may wait a day or so. Any changes come into effect one month later.

What will it mean for my mortgage?

Fears over a rise in inflation have already put up mortgage costs.

The 26 per cent of borrowers on rates linked to the base rate (such as trackers, discounted mortgages or SVRs) will see their rate go up in line with the base rate almost immediately. Lenders will write to tell you how much more expensive your payments will be.

Those on a fixed rate will not be affected until their term ends, but will find rates will be higher when they come to get a new deal.

The Bank of England said inflation could be as high as 5 per cent next year, which has already pushed up mortgage rates.

What about savers?

They are supposed to be the winners from a base-rate rise because they earn more by parking their cash in the bank. However, this isn’t necessarily the case.

The last time the base rate increased, from 0.5 per cent to 0.75 per cent in August 2018, five of the biggest banks increased easy-access rates by an average of 0.09 per cent. Two others didn’t increase rates at all. Banks also always cut rates on their accounts by more when the base rate falls than they increase them when it rises, to boost their margins.

Still, a base rate rise should improve rates on easy-access accounts a little — the best you can get at the moment is 0.66 per cent.

The rates on fixed savings accounts have gone up, so experts think a base rate rise has already been priced in.

Should I fix my mortgage now?

Although some rates have started to creep up, fixed rates are still very cheap by historical standards.

You can still get a two-year fix at 0.99 per cent, a five-year fix at 1.13 per cent and even a ten-year deal at 1.95 per cent.

If you are worried about falling onto a bank’s standard variable rate, which will increase in line with the base rate, then consider fixing for the peace of mind of set repayments. You can usually secure a mortgage rate six months before your existing deal expires.

Will rate rises affect house prices?

More expensive loans and tighter affordability requirements from banks could suck the oxygen out of the property market as homeowners choose to stay put.

The Office for Budget Responsibility last week forecast that house prices will continue to rise until 2027, but by less than the 11 per cent boom this year. It said that if inflation hit 5 per cent, however, leading to the base rate going up to 3.5 per cent, then house prices could fall.

Nationwide Building Society’s chief economist, Robert Gardner, said a base rate rise would have a “cooling effect” on the property market.

When will rates rise?

It depends on how the economy is doing. If supply chain issues continue to dent growth and push up prices it could be next month. At 0.1 per cent, the base rate is the lowest in the Bank of England’s 326-year history and it expects it to top 1 per cent next year, the highest since 2009.
George Nixon