To what extent can your household finances come under pressure in the coming years? The answer may very well come down to the amount of your mortgage.
If you’ve borrowed a lot of money to buy your dream home, rising interest rates could curb the purchasing power of the middle class much more than rising utility bills have hitherto done.
I have a friend who has been paying an extra £500 a month on her mortgage since she got a fixed income deal. She has to move in a year for school-related reasons, so she didn’t want to get bogged down in a new solution.
Last week, when the Bank of England raised its base rate by half a percentage point — the largest increase in 27 years — it sent me a WhatsApp message that read “Arrrrrrghhhh”.
Most British borrowers have kept a fixed interest rate, but according to the trade organization UK Finance, about 1.3 million will expire this year and 1.81 million next year.
Data from the Bank of England shows that more than £10bn was overpaid on mortgages in the first six months of this year – a trend demonstrated in FT Money’s bonus survey in February, where 13 percent of respondents said this was your intention.
Rising real estate prices, higher mortgages and longer repayment terms mean that even a small change in interest rates will increase the lifetime cost of your home loan.
Here are some points to consider well before your current solution expires.
Get your paperwork in order
Anyone with a fixed mortgage should plan what to do when it expires. Find the date, mark it in your calendar and start looking for a new deal at least six months in advance.
“The number of mortgage applications that lenders are getting is still at a very high level, and we’ve seen two or three pauses in new business taking as they get back up to speed,” said Andrew Montlake, general manager at mortgage broker Coreco.
He’s heard stories of clients waiting three to four weeks for a mortgage assessment appointment while interest rates have risen.
If you stick with the same lender, remortgaging deals — known as retention products — usually can’t be secured until you have less than four months to spare. But if you switch to a new lender, it’s often possible to lock in a rate six months before your current deal expires.
Expect to pay around £500 for an independent mortgage broker to help you find the best deal for your circumstances.
Careful preparation prevents the misery of falling back on the standard variable interest rate (SVR) of your lender. The average SVR is already 5.17 percent, according to Moneyfacts, the price comparator.
This figure has risen for eight straight months and is likely to increase further, resulting in a massive payment shock for those rolling out a fix.
How long to repair?
You won’t thank me for saying the best time to set your mortgage was six months to a year ago.
Five-year fixes are still the most popular product, but the average rate offered for these deals crossed 4 percent in August, according to Moneyfacts — a level last seen in 2014.
The two-year average fix is a shadow below that at 3.95 percent.
The more equity you have in your home, the better the interest you can get. However, deals with the lowest rates tend to have the highest costs (usually £1,000 or more). Add the costs to your loan and you pay interest on top of that.
Mortgage brokers are reporting early signs that more borrowers are willing to bet on a two-year fix, in hopes that a recession will force central banks to cut interest rates.
Well-known American investors Cathie Wood and Ray Dalio have both said they expect rate cuts in 2023-24. However, non-billionaires will likely appreciate the security of a fixed rate on their biggest monthly expense.
Be prepared to make a quick decision
Whether you’re buying or refinancing a home, speed is essential. The average mortgage product has an average shelf life of just 17 days, according to Moneyfacts – an all-time low.
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If a lender’s interest rate rises to the top of a best-buy table, they will often withdraw it quickly to avoid the operational challenge of a deluge of applications.
“I could give a customer one rate at 9 a.m. and then have to call back at 12 a.m. and say the deal will be revoked at 5 p.m. today,” Coreco’s Montlake said. “Some customers think it’s a sales technique, but that’s the reality of the market.”
Do you have to pay to nix your current solution?
With rates rising, you may be tempted to pay a fine to end your existing deal and close a new one.
As a rule of thumb, the cost of early repayment on a five-year commitment is 5 percent of the outstanding balance in the first year and gradually decreases to 1 percent in the last year.
Breaking a £500,000 mortgage with two years left could cost you £10,000, plus product costs for the new mortgage – and your monthly repayments would be immediately higher.
Is it worth it? A free mortgage calculator from the budgeting app Nous.co tries to answer this question based on market predictions about where interest rates might be by the time your fix ends and what the likely costs or savings might be.
i would use one too calculator for overpaid mortgage to see what impact using that money to make a one-time payment could have, assuming your mortgage agreement allows it, and whether it could lead you to a lower LTV. Sprivea new app, allows people to vary their overpayments according to their monthly expenses.
What about rental mortgages?
Landlords more often have interest-only mortgages. While most are locked into fixed-rate deals, this means they’re exposed to much greater cost fluctuations than borrowers who pay off when the interest rate expires.
Lenders apply a series of affordability calculations to buy-to-let loans. The most important is the interest coverage ratio — the monthly rent expressed as a percentage of your monthly interest payment — usually 125 to 145 percent.
However, lenders use a “stress rate” to calculate these ratios and this is much higher than the actual interest paid on the loan.
David Hollingworth, associate director at brokerage L&C Mortgages, notes that several lenders increased their stress rates this month and expects others to follow. “As a result, landlords will have to charge higher rents to borrow the same amount,” he says.
For example, Metro Bank just raised one of its stress rates from 4 to 5.5 percent and is demanding 140 percent interest coverage.
On a £200,000 interest-only mortgage, he calculates that this would mean landlords would need an additional £350 in monthly rental income to meet the lender’s requirements.
As we heard on this week’s Money Clinic podcast, tenants are already seeing these increased costs being passed on to them, with letting agents in London reporting rent increases of 40 percent on lease renewals.
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As much as rising mortgage rates make you scream, be thankful you own your home.
Claer Barrett is the consumer editor of the FT: claer.barrett@ft.com; Twitter @Claerb; Instagram @Claerb