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Mortgage rates: act fast as increases loom

Rising mortgage interest rates are piling pressure on millions of UK homeowners at a time when soaring bills for energy, food and fuel are blowing holes in household budgets across the country.

The choices facing mortgage borrowers are set to worsen next week, when the Bank of England is widely expected to raise its main interest rate for the seventh time since December.

Most borrowers will have protected themselves from the immediate impact of any decision by opting for a fixed-rate mortgage deal. But those who fixed at a time of ultra-low rates may be in for a shock when they refinance, with the average two-year fix now coming in at over 4 per cent.

“The base rate changes are coming thick and fast,” says David Hollingworth, director at mortgage broker L&C. “Those who are just feeling buffeted from all sides need to get hold of it and if they’ve not done anything about reviewing mortgage rates that should be the priority.”

Making sure you’re getting the best available deal is just one of the steps borrowers can take to mitigate the pain of interest rate rises. FT Money explores some of the options for those confronting a home loan crunch.

Move fast

Lenders’ standard variable rates, which tend to track BoE base rate changes, show the extent to which rate changes have affected household budgets.

In early December 2021, when the BoE’s main interest rate was at 0.1 per cent, standard variable rates at big lenders such as Nationwide and Halifax were around 3.59 per cent. Since then, six successive increases have brought base rates up to 1.75 per cent — and SVRs have risen to around 5.24 per cent, according to L&C.

In December, someone with a £300,000 mortgage on SVR would have paid £1,516 a month in interest. At current rates, they pay an additional £280 a month. But if the base rate hits 2.25 per cent next week, that extra monthly figure could reach £370, L&C estimates.

Most borrowers already know to avoid SVR, typically the most expensive form of mortgage borrowing in a lender’s arsenal, though Hollingworth points out many will have drifted on to these rates at a time when the difference between SVR and other options mattered less. Increasingly, therefore, fixed-rate deals are becoming the only game in town.

Among new buyers, 19 out of 20 (95.5 per cent) are taking out a fixed-rate mortgage, according to the Financial Conduct Authority, while 17 out of 20 mortgaged homeowners have fixed their rates. “More homebuyers are taking out mortgages with fixed rates than ever before,” says Lawrence Bowles, director of research at estate agent Savills.

GM170916_22X UK fixed rate mortgage

By opting for fixed-rate mortgages, borrowers are seeking to lock in rates in expectation of further rises later. But the costs of this type of deal are rising fast, too. Borrowers now looking for another offer as their fixed period comes to an end will face much more expensive terms. Average rates on a two-year fix have nearly doubled from 2.24 per cent a year ago to 4.24 per cent this week, according to finance website Moneyfacts.

Not only that but banks and building societies are rapidly paring back the number of home loans they offer. Over 500 deals were pulled from the market in the month to September, Moneyfacts found. There are now 1,425 fewer deals available than at the beginning of December 2021.

Lenders often struggle to cope with demand if their deals top the ranks of the “best buys” on the market and they find themselves attracting a flood of customers. This can be frustrating for borrowers who identify a deal, only to find it withdrawn by the time they apply.

Last week, for instance, Barclays withdrew six mortgage products only a day after it introduced them, citing the challenges lenders face “when balancing service with product availability”. This week it raised the rates on 20 of its deals by 0.4 percentage points.

The upshot for borrowers is that they should be ready to grab a rate as soon as it looks like a good fit for their requirements. Aaron Strutt, technical director at mortgage broker Trinity Financial, says: “Most mortgages last longer than a day, but in many cases they may only be available for three or four days, with many lenders sending multiple rate change emails each week.

“If you find a rate that you like it’s worth securing it quickly because it will not be around for long.”

Beat the deadline

This autumn and next year, a wave of UK homeowners will come to the end of their fixed mortgage deals secured during the good times of ultra-low rates. UK Finance, the trade body, estimates 1.8mn people will see their fix elapse in 2023.

Mortgage costs have risen this year but are expected to rise further, even as August’s inflation figures came in this week lower than anticipated, with the consumer prices index levelling off at an annual 9.9 per cent.

The good news for borrowers facing a refinancing crunch next year is that many lenders will allow them to secure a fixed-rate deal well ahead of the end of their current fix. A mortgage offer will typically be valid for up to six months, so borrowers can bank a lower rate with a view to completing it once their current deal comes to an end.

That benefits them in two ways, says Hollingworth. “It gets ahead of any further increases in fixed rates that might feed through — which currently still remains the direction of travel. Second, they get the benefit of the remainder of any lower rate they currently enjoy.” 

Borrowers should even consider starting the process ahead of the six-month offer period, says Simon Gammon, managing partner of broker Knight Frank Finance, since some lenders such as Nationwide will honour the rate on which they apply for the mortgage. “You have up to three months in which to get the mortgage offer approved at that rate. And once it’s approved, you then have six months in which to draw it down,” he says.

Some borrowers may consider a “clean break” to be preferable, by coming out of their current fix early — in spite of incurring early repayment charges — and moving to another, perhaps longer-term, deal straightaway. But brokers say they should exercise caution before giving up an attractive current deal.

Line chart of  All loan to value (%) showing Average fixed mortgage rates

“You won’t know until you’ve got the luxury of hindsight as to whether that was a good decision or not — because you don’t know how rates will progress from here. And you’ll have a hefty repayment charge to contend with in most cases,” says Hollingworth.

Borrowers seeking to refinance must decide whether to stay with their current lender — an option known as a “product transfer” — or remortgage elsewhere. In recent months, lenders have improved rates on product transfers to keep customers loyal. But these transfer deals may only be locked in three to four months ahead of the expiry of the existing rate, notes Chris Sykes, technical director at broker Private Finance.

At a time of rapidly changing interest rates, borrowers must trade off the possibility of securing an attractive deal now with a new lender against a discounted “loyalty” rate from the existing lender closer to the moment of expiry.

“The best advice [is] usually to secure a remortgage as early as possible then re-look at things nearer to the time of product renewal, potentially then doing a product switch instead,” Sykes says.

Repay or restructure

One reason to hang on to an existing fix until it ends is that it gives borrowers an option to overpay while their effective interest rate is low, reducing the total size of their mortgage and potentially giving them access to better rates in future.

For those fortunate enough to be able to do this, most lenders allow overpayments of up to 10 per cent a year. With other household bills climbing steeply, doing so in the long run should mean you’ll have to set aside less of your overall budget to pay for the mortgage.

But there are other, more radical, ways of reducing the size of your monthly payments. First, if you think you will be unable to make your repayments and fear you will fall into arrears, your lender might allow you to move temporarily to an interest-only arrangement, cutting your monthly commitments substantially. They will usually only allow this where borrowers have a set minimum of equity in the home and with loan-to-value levels towards the lower end of the scale.

Ray Boulger, senior mortgage technical manager at broker John Charcol, says one strategy would be to switch to interest-only to slash your monthly payments, and then — if you can afford it — pay up to 10 per cent of the overall debt without incurring a repayment charge.

GM170914_22X Money BoE

“You’ve got a much lower commitment, but you’re contractually meeting your obligations. And then if you choose to overpay, that’s absolutely fine. Whereas if you’ve got to retain the mortgage and you simply underpay, even though you’re paying all the interest, you’ll be deemed to be in arrears and then you’ll get a bad credit rating.” 

Keeping a clean credit history is a major consideration. Going into arrears makes it much harder to get another mortgage and, even if you can, lenders are likely to charge you a higher rate, which compounds potential payment problems. Boulger adds that anyone considering a short-term or permanent switch on to interest-only needs to scrutinise the terms with the bank. “If you are going to change your mortgage conditions, always ask the lender to confirm that it won’t adversely affect your credit rating.”

A second way of cutting your monthly payments is to extend the term of your mortgage, so it is repaid not over, say, 25 years, but 30 or 40. This won’t always be possible, given lenders’ rules on the age by which you must have paid off the loan, but some will be more flexible than others.

“It won’t have as big an impact as switching to interest-only, but it may still be enough to get you over any short term financing problems,” says Boulger. He warns, though, that taking longer to pay back your mortgage means you’ll pay more interest over the term of the loan, raising your costs in the long term, if not the short.

Scale back your ambitions

It has been a year of high demand among homebuyers and short supply at estate agents, pushing up property prices and encouraging buyers to stretch themselves financially to outbid rivals. But there are signs that buyers are tempering their aspirations.

Interest rates rises and the cost of living have started to impact buyers’ budgets, according to a survey this week by Savills. Almost a third (29 per cent) of 1,000 prospective buyers quizzed in late August said they had cut back their budgets because of these factors. The proportion was higher for those with mortgages: some 44 per cent of those looking to move to a new home said they had reduced their budget.

“Despite transactions remaining robust over the summer months, there’s now certainly less urgency in the market, with rising costs of debt impinging on the budgets of those most reliant on a mortgage. Increased costs of living are also making buyers much more conscious when it comes to how much they are willing to spend,” says Frances McDonald, Savills research analyst.

Gammon at Knight Frank Finance says the shift in mood among buyers seeking mortgage finance has been tangible over the past month, as the “sellers’ market” of the past two years fades.

“We’re seeing those who are looking to buy a property starting to pause and say — actually, I’ve rerun the numbers and I just can’t afford a mortgage that big any more. They say they’ll have to check with their wife or husband about what’s realistic, because this has suddenly gone from very affordable to a real stretch.” 

Higher earners are also changing their behaviour when it comes to the costs of debt. Lisa Parkes, a private banker at Investec, describes a longstanding British client with a £3mn mortgage facility on a £5mn home. This “revolving mortgage” allows him to draw down cash to put into investments or second home purchases as and when he chooses, or to repay it with no penalties charged.

“He’s always valued flexibility in having access to liquidity,” she says. Now, though, the expense of maintaining such a credit facility has brought him back to a much more mainstream mortgage model. “We’re looking at a 70 per cent loan-to-value on a five-year fixed . . . That price differential has never been a concern for him in the past, but now it is.”

She notes similar concerns among other clients. “It’s unprecedented, really.”

The five-year fixed deal has become the arrangement of choice. At 4.33 per cent for the average five-year deal, compared with 4.24 for the two-year, Moneyfacts data suggests there is little to choose between them when it comes to rates.

Gammon says less than half of the deals coming through the broker a year ago would have been fixed for five years or more. “Now two-thirds of the deals we’re doing are on long-term fixed rates.” 

Readers who lived through previous eras of mortgage distress may regard current worries over potential rises in interest rates to be overblown; in 1989, after all, base rates hit 14 per cent, and 17 per cent in 1979. But a return to “normal” base rates would have a much more serious effect on borrowers’ finances now, says Neal Hudson, director of market research company Residential Analysts.

“Mortgages are now at much higher multiples of income . . . and most are on a repayment basis. This leaves current borrowers very exposed to even slightly higher rates, let alone those at 4 per cent plus,” he says.

Hudson illustrated the difference by calculating what today’s mortgage rates would have to be to match the mortgage repayment ratios of previous years. The results are sobering: repayments under the 14 per cent rate of 1980 are equivalent to repayments today at a rate of 3 per cent.

As the rate rises look likely to clock up for months to come, borrowers would be wise to revisit their financial assumptions and ambitions.

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