How much could your household finances be reduced in the next few years? The answer may well come down to the size of your mortgage.
If you’ve borrowed a lot of money to buy your dream home, rising interest rates have the potential to dampen the purchasing power of the middle class far more than rising energy bills have. done so far.
I have a friend who has been paying £500 a month more on her mortgage since she got a fixed rate deal. She has to move in a year, for school-related reasons, so she didn’t want to lock herself into another solution.
When the Bank of England raised the base rate by half a percentage point last week – the biggest increase in 27 years – it sent me a WhatsApp message saying “Arrrrrghhhh”.
Most UK borrowers have locked in a fixed rate, but around 1.3 million will expire this year and 1.81 million next year, according to trade body UK Finance.
Bank of England data shows more than £10billion was overpaid on mortgages in the first six months of this year – a trend highlighted in the FT bonus survey Money in February, where 13% of respondents said that was your intention.
Soaring house prices, larger mortgages and longer repayment terms mean that even a small change in interest rates will increase the lifetime costs of your home loan.
Here are some things to consider long before your current patch ends.
Put your papers in order
Anyone with a fixed rate mortgage needs to plan what to do when it expires. Find the date, mark it in your calendar and be ready to start looking for a new offer at least six months in advance.
“The number of mortgage applications received by lenders is still at very high levels, and we’ve seen a couple of them stop taking new business while they get back on track,” says Andrew Montlake, general manager of mortgage broker Coreco.
He heard stories of clients waiting three to four weeks for a mortgage review appointment, during which time interest rates rose.
If you stay with the same lender, remortgage deals – called retention products – usually can’t be secured until you have less than four months left. But if you’re changing lenders, it’s often possible to “lock in” a rate six months before your current contract expires.
Expect to pay around £500 for an independent mortgage broker to help you find the best deal for your situation.
Careful preparation should save you the misery of reverting to your lender’s standard variable rate (SVR). The average SVR is already 5.17%, according to Moneyfacts, the price comparator.
This figure has risen for eight consecutive months and is likely to inflate further, adding to a huge payment shock for those dropping out of a solution.
How long to fix?
You won’t thank me for saying that the best time to fix your mortgage was six months to a year ago.
Five-year patches are still the most popular product, but the average rate offered on these deals topped 4% in August, according to Moneyfacts — a level last seen in 2014.
The two-year average fix is slightly lower at 3.95%.
The more equity you have in your home, the better rate you can get. However, the offers with the lowest rates tend to have the highest fees (usually £1,000 or more). Add the fees to your loan and you’ll pay more interest.
Mortgage brokers are signaling early signs that more borrowers are willing to bet on a two-year fix, betting that central banks will be forced to cut rates in the event of a recession.
High profile US investors Cathie Wood and Ray Dalio both said they expect to see rate cuts in 2023-24. However, non-billionaires are likely to appreciate the certainty of a fixed rate on their most important monthly expenses.
Be ready to make a quick decision
Whether you’re buying a home or paying down, speed is key. The average mortgage product has an average life of just 17 days, according to Moneyfacts – an all-time high.
If a lender’s rate moves up a best buy chart, they will often withdraw it quickly to avoid the operational challenge of a deluge of inquiries.
“I could give a customer a rate at 9:00 a.m. and then have to call back at noon and say the offer is off at 5:00 p.m. today,” says Coreco’s Montlake. “Some customers think it’s a sales technique, but it’s the reality of the market.”
Should you pay to undo your current patch?
With rising rates, you might be tempted to pay a penalty to exit your existing deal and lock in a new one.
Typically, the five-year prepayment charge is 5% of the outstanding balance in the first year, falling on a sliding scale down to 1% in the final year.
If you break a solution on a £500,000 mortgage with two years to run, it could cost you £10,000, plus product charges for the new mortgage – and your monthly repayments would be instantly higher.
Is it worth it? A free mortgage calculator from the Us.co budgeting app attempts to answer this question based on market predictions of potential interest rates at the end of your repair and likely costs or savings.
I would also use a mortgage overpayment calculator to see what impact using that money to make a one off payment might have, assuming your mortgage agreement allows it, and if it might tip you into an LTV inferior. Sprive, a new app, lets people vary their overpayments based on their monthly expenses.
What about rental mortgages?
Homeowners are more likely to have interest-only mortgages. Although most are locked into fixed rate agreements, this means they will be exposed to much greater cost fluctuations than repayment borrowers when rates expire.
Lenders apply a range of affordability calculations to buy-to-let loans. The principal is the interest coverage ratio – the monthly rent expressed as a percentage of your monthly interest payment – usually 125-145%.
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, managing partner at brokerage L&C Mortgages, notes that several lenders have increased their stress ratings this month and expects others to follow suit. “The result will be that landlords will have to charge higher rents to borrow the same amount,” he says.
For example, Metro Bank just raised one of its stress ratings from 4% to 5.5% and requires 140% interest coverage.
On a £200,000 interest-only mortgage, he calculates this would mean owners would need an additional £350 of monthly rental income to meet the lender’s requirements.
As we heard on the Money Clinic podcast this week, tenants are already seeing these higher costs being passed on to them, with London letting agents reporting 40% rent increases when renewing leases.
Even if rising mortgage rates make you want to scream, just be grateful that you own your home.