Mortgage holders can breathe a sigh of relief after the Bank of England decided last week to leave borrowing costs at an all time low – but it came with the warning that interest rate rises are on the way. The current 0.25% rate is the lowest in the bank’s 323-year history and changes upwards could lead to homeowners, who have borrowed at the reduced levels, to face increases in their bills in the near future.
“Just a slight rise to the Bank of England base rate could really hit consumer finances hard, and it’s not something they would see coming, considering the low interest rate environment today,” says Rachel Springall, of the financial data website Moneyfacts.
So what would the effects of a rate rise be for the average household?
Where we are
There has been speculation about when rates will rise for some time and any change would mark the end of a decade of historic lows.
Last week the Bank of England’s rate-setting committee voted to leave borrowing costs where they are – but with the warning that the situation would not stay the same for much longer. Mark Carney, the governor of the Bank of England said they were likely to rise by more than the markets are expecting.
In the latest forecast from the National Institute of Economic and Social Research (NIESR), the thinktank revised its predictions for a hike to the first three months of next year, instead of in 2019 – accelerating the likelihood that mortgage holders will soon be facing higher bills.
David Hollingworth, of the mortgage broker London & Country, says it is now expected that the rate rise will come sooner, rather than later. “Borrowers would run the risk of being complacent to think that the threat of a rate rise has disappeared,” he said.
What will it cost?
The cost of an interest hike will vary per household, depending on the terms of the mortgage, how long it is taken out for, and whether it is on a fixed or a variable rate.
Figures from Moneyfacts show that a family with a £200,000 mortgage on a 25-year term will pay almost £25 a month extra if the rate goes up by 0.25% – almost £300 a year. This doubles if the rate goes up by 0.5% to £600 – the price of a week-long package holiday in Turkey for two from Thomas Cook. If the rate goes up by one percentage point, then the cost would be just over £100 a month, or over £1,200 a year. A family with a £150,000 mortgage pays about £650 in instalments on a two-year fixed term at 2.24% – this rises by almost £19 a month with a 0.25% rise, £37 with a 0.5% hike and £76 if the rise is 1%.
Those with a loan of £250,000 would face increases of £31, £62 and almost £128 every month, under the three bands. A year with a 0.5% rise would mean the mortgage holder paying just over £750 extra.
David Blake, from Which? Mortgage Advisers, said that borrowers need to plan ahead and understand the implications of a rate rise.
“For those on a lender’s standard variable rate, a rise in interest rates has the potential to have a big impact. Those on a fixed rate won’t be impacted until the end of their fixed term. I would urge anyone who finds themselves on a variable rate to speak to an independent mortgage broker to find out their options,” he says.
Are people at risk?
The growing amount of debt amongst consumers is of great concern to campaigners and charities. Warnings that the bubble of unmanageable consumer debt is growing at an alarming rate peaked recently when the Bank of England told lenders that they face action against reckless practices amid a “spiral of complacency” – mostly surrounding credit cards, car finance and cheap personal loans.
Concern has been expressed at the length of mortgages being taken out now, with 35-year terms accounting for over 15% of new loans in the first three months of this year – up from 2.7% in 2005 – which means homeowners are saddled with more debt for longer. Reports have also indicated a rise in the number of mortgages with the amount borrowed more than 4.5 times the income of the borrower, suggesting that people are taking on more debt.
Mortgage professionals working in the area point towards tougher regulations providing a safety net against a swathe of homeowners being unable to afford their repayments.
Hollingworth says: “High house prices mean that many borrowers will have stretched their mortgage borrowing to the upper limits when buying in recent years. However, tighter controls on mortgage lending should mean that borrowers have had to demonstrate that they can afford the mortgage borrowing, not just now, but that it will also be sustainable in future through the stress testing that lenders will apply.”
Jonathan Harris, director of mortgage broker Anderson Harris, says greater stress testing means that those who borrow high multiples of their income will only be able to do so “if everything else stacks up”. Ray Boulger, of broker John Charcol, said problems of repayment are more likely to arise from people losing their jobs or splitting up with a partner.
Blake says: “Lenders are required to future-proof their lending and so stress test their borrowing at higher assumed interest rates of around 5% to 7%. This is to make sure borrowers can afford their mortgage in the event of rate rises.”
However, Springall points out that, regardless of the checks, there are still those who could find themselves unable to pay. “There are tighter affordability checks to prevent borrowers from getting a mortgage beyond their control but, still, there will be consumers out there whose circumstances change and who could end up defaulting.
“We may see a boom in the number of people putting their houses up for sale as an attempt to downsize but, if house prices fall, it’s likely homeowners will be reluctant to put their property up for sale until the market recovers,” she adds.
What can be done?
The Bank of England has said it expects rate rises to be gradual. But Blake says: “I would encourage those who have not reviewed their mortgage recently to do so, even if they are tied into their existing product, as it might well make sense to look towards the future whilst rates are low.”
Fixed-term rates are at a record low at present, according to Hollingworth. He highlights Yorkshire Building Society’s 0.99% two-year fixed term and HSBC’s five-year fixed term at 1.59%, although both come with conditions. As the time for a rise draws nearer, however, the offers from banks will increase in cost.
“They are at, or near, record lows but as a rate rise draws nearer that will begin to weigh on the rates that lenders can offer and edge rates up. Switching to a better rate now could cut monthly payments substantially, but also remove that vulnerability to the impact of increases in the base rate,” he says.
Migrating to a fixed rate may not, however, be a long-term solution, says Springall. “Borrowers on a fixed-rate mortgage over the longer term can breathe a sigh of relief as repayments will remain unchanged if the base rate were to rise. However, at some point they will come off their deal and may well need to stump up more cash on repayments if rates do rise.”
Harris says overpaying now at a time of low rates could insulate against rises. “Most lenders will let you overpay by up to 10% of the mortgage amount a year without penalty,” he says.
This will result in a lower rate of mortgage debt when rates do eventually go up, Blake adds.