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Interest rates are on the rise and many people are panicking (understandably so) about their remortgage renewals or the cost of buying a home now.
So, in this article, we’re going to be discussing interest rates.
The Base Rate (otherwise known as the Bank Rate) is the interest rate that the Bank of England charge commercial banks to borrow money. This includes mortgage lenders.
If the Base Rate increases, funding for commercial banks becomes more expensive. If they decrease, borrowing becomes cheaper.
The Bank of England monitor and make changes to the Base Rate to keep inflation in line with Government targets. The Monetary Policy Committee meet regularly to review and discuss the Base Rate.
Currently, the target for inflation is 2% per year. However, the current inflation rate at the time of reviewing this article is still far above.
The Base Rate was introduced back in 1694 and has fluctuated over time.
We’ve had the all–time high of 17% back in November 1979 to the all–time low rate of 0.1% in March 2020.
Following the financial crash in 2008, the Bank of England cut the Base Rate significantly in an attempt to boost the economy. The rate decreased from above 5% in 2008 to as low as 0.25% by August 2016.
The Base Rate dropped further to 0.1% in March 2020 due to the impacts of COVID.
The Base Rate had remained so low for such a long time, which has made many mortgage borrowers accustomed to such low interest rates on their mortgages.
So, it is no wonder that the Base Rate increases starting from December 2021 caused a bit of a shock and worry.
You can find out more on the history of the Base Rate on the Bank of England website.
When the Base Rate increases, mortgage rates tend to increase.
These mortgage rates do not necessarily increase by the same percentage as the Base Rate, as there are many other factors involved.
If mortgage rates increase, monthly mortgage payments increase and therefore the amount of disposable income for mortgage borrowers decreases.
The aim for the Bank of England here is to decrease inflation.
When the Base Rate decreases, mortgage rates tend to decrease.
Again, not necessarily by the same percentage.
This has the opposite impact of increasing rates – people will have more disposable income, therefore potentially leading to increased inflation with more public spending.
Let’s assume you fixed your mortgage rate for 5 years in 2016 (when the Base Rate was 0.25%) on a rate of 1.5%. The mortgage balance was £300,000 over a 35-year mortgage term.
This would result in a monthly repayment of £918.55.
Now let’s look at the same example with the Base Rate being 5.25%.
With the same example, let’s assume that the increase in the Base Rate means your mortgage rate available is 6%.
This would result in a monthly repayment of £1,710.57. That’s an increase of £792.02!
Therefore, when you’re looking to take out a mortgage, it’s important to factor in potential increases in interest rates to ensure you can afford the mortgage if your monthly repayments increase.
It is possible of course, but I believe it is unlikely.
Again, this is my opinion and I could be wrong.
Why? Well, mortgage borrowers are not the only borrowers.
One large borrower is the Government. If we look at the level of Government debt over the years in relation to GDP (Gross Domestic Product), historic Base Rate highs would cost the Government far more than what it would have done in the 1970s.
There’s so many factors involved in setting Base Rates.
There’s also many factors when it comes to setting mortgage rates. This ranges from lenders wanting to be competitive with each other, but also factors such as swap rates can make an impact.
Swap rates are very complicated, but in a nutshell they are what lenders pay to financial institutions in return for a fixed amount of funding.
These swap rates can be priced based on 1 year to 15+ years.
For those of you who want to learn more about this, you can search for the SONIA (Sterling Overnight Index Average) rate swaps.
The important thing is that rate swap prices can impact the interest rates that lenders charge.
It can also hint at an indication of where financial markets predict interest rates will be like in the future, but there is no guarantee of course.
How? If swap rates are priced higher, it eludes to the markets believing rates will be higher and vice versa.
That said, these swap rates change very regularly, so it’s very tough to predict where rates are heading. Therefore, when arranging a mortgage product, you should factor in potential increases in interest rates.
One way to help avoid impacts of increasing interest rates is to arrange a fixed rate mortgage.
When you have a fixed rate mortgage, you are not affected by changes in interest rates for the duration that your fixed rate applies.
Other types of interest rates, such as tracker and discount rates, come with the risk of fluctuating when there are changes to interest rates.
There is no right or wrong when it comes to how long you should fix your mortgage for, if it is a fixed mortgage that you’re after.
It is important for you to do your own research and it can be helpful to speak with a mortgage broker for advice regarding your specific circumstances.
We, or any other mortgage broker, do not have a crystal ball, so we will not be able to tell you what exactly will happen with interest rates, but we can help provide the information you need to make an informed decision.
If you’re currently sitting on the lender’s standard variable rate, you really should be looking at your remortgage options.
Whether you prefer a fixed or a variable rate, there’s a strong likelihood that there’s a better option out there for you than just staying on the standard variable rate.
Speak it through with your mortgage broker to see what your options are, and potentially save a bit of money straightaway.
If you’re hoping to buy your new home or you have an upcoming remortgage, and you’re struggling to see how you’re going to afford the monthly payments available at the moment, there’s a couple of options that you can consider to potentially bring those monthly payments down.
One option would be to look at an increased mortgage term.
A mortgage term is the amount of time that the mortgage runs for in full.
You can potentially increase that term, which will then reduce the monthly payments.
It’s not an option that’s available to everyone, for example you might already have the maximum mortgage term available to you, based on your circumstances.
However, it’s something that’s worth asking your mortgage broker.
You can then have a discussion to understand what the implications are (the main implication being that you will pay higher interest overall if you’ve got a longer term).
This doesn’t have to be a long-term solution, either. It could just be a temporary solution for the next couple of years – you can then review your options from there, potentially reducing the term as part of a future remortgage.
Alternatively, you can look to make overpayments to reduce the term quicker, if your circumstances allow it. Just check for any penalties that might apply.
If you’ve looked at the option of a longer mortgage term and you’re still really struggling to see how you’re going to afford the monthly payments, you can see whether or not you’d be eligible to get an interest only mortgage.
This is not an arrangement that we would usually recommend for a residential mortgage, however if you’re out of options, an interest only mortgage would provide cheaper monthly payments.
Again, it’s really important that you speak through the pros and cons with your mortgage broker.
The main consideration with an interest only mortgage is that you will not be paying down any of the debt on a monthly basis – you’d only be paying interest.
This is why the monthly payments are lower with this arrangement, compared to a standard capital repayment mortgage.
For an interest only arrangement, you must consider how you’ll repay the mortgage at the end of the mortgage term.
As mentioned with the longer mortgage term scenario, the interest only arrangement does not necessarily need to be for the full term of the mortgage – you could potentially arrange this over the next couple of years review and consider changing this back to a capital repayment basis thereafter (i.e. when remortgaging).
These are a couple of examples of ways in which you could reduce your monthly mortgage payments, however there may be alternative options available depending on your circumstances – speak with your mortgage broker.
In difficult times like this, small changes can make a big difference.
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As a mortgage is secured against your home or property, it may be repossessed if you do not keep up the mortgage repayments. Think carefully before securing any other debts against your home or property. The Financial Conduct Authority does not regulate commercial buy to lets and some forms of commercial mortgages. You may have to pay an early repayment charge to your existing lender if you re-mortgage
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