Is a mortgage shock on its way for homeowners
The Bank of England (BOE) has raised interest rates by over 150 basis points in less than a year. Admittedly, the background is slightly skewed as the bank slashed its interest rates to historic lows because of the pandemic. Nonetheless, the current rate is still 100 basis points above the pre-pandemic rates and the highest in over a decade.
Why are interest rates rising so rapidly
BOE is raising interest rates at a record pace as it tries extremely hard to tame inflation, as it continues to soar at an annual rate of 10.1 per cent, which is well above the BOE’s target of 2 per cent and at a 40-year high. Analysts predict that by March of next year, the base rate would have risen to 4 per cent, making it a 390 basis points increase in a year.
With Goldman Sachs predicting that UK inflation will exceed 22 per cent due to high energy prices, the bank is likely to continue its interest hikes. Whether or not the interest rates rise will help slow down inflation is debatable. High inflation has been a direct result of supply chain issues from Asia, the Ukraine war impacting the energy prices and OPEC+ countries unwilling to increase oil production to pre-pandemic levels. Raising interest rates might not have the impact that BOE is hoping for, but it is one of the few tools it has to showcase that they are trying to do something about it.
Why homeowners might be in for a mortgage shock
The last time the interest rates rose so fast was back in 1988-89 when interest rates rose from 7.38 per cent to 13.75 per cent. The interest rates rise along with the oil crisis due to Iraq’s invasion of Kuwait led to high inflation and a housing market crash, where house prices fell by 20 per cent between 1989 & 1993.
It would sound very familiar if we were to compare the current situation. The Ukraine war has caused the energy crisis and high inflation for various reasons listed above and is leading to BOE raising interest rates at a record rate. The only difference we can argue was the labour market, where the unemployment rate between 1988 and 1993 topped at 10.6 per cent, as opposed to now, where the unemployment rate is at 3.8% (ONS).
The issue, however, is that according to the Office for National Statistics (ONS), wage growth is not keeping pace with inflation. ONS reports that regular pay, when adjusted for inflation, fell by 2.8 per cent in real terms, which is a record fall in regular pay.
If wage growth continues to fall in real terms when adjusted with inflation and if the BOEs interest rate rises do not have an impact, it hopes to bring down inflation. The interest rates rise will only add further squeeze on households.
According to data company Moneyfacts, the cheapest mortgage rates have tripled from less than 1 per cent in December 2021 to more than 3 per cent; the average two-year fixed deal is now 4.09 per cent. On a 200,000 mortgage for two years, a typical homeowner would pay £1,224 more compared to a year ago.
What can you do
If you are currently on an older deal, you will face an increase in the future and should start preparing now.
Make Overpayments:
If you can afford it, you should think about making overpayments. Most lenders will allow you to overpay on your mortgage by 10 per cent every year. It will leave you with a smaller mortgage when your current deal expires, and you will be less exposed to interest rates hike.
Extend the term of your mortgage:
If making overpayments is not an option, then you could speak to your bank about extending the term of your mortgage. It will help bring your mortgage payments down. According to Moneyfacts, on a £500,000 mortgage at 3.24 per cent over 25 years, you would pay £2,434; by extending the term of the mortgage by ten years to 35 years, you reduce your monthly payments by £443 a month. It will, however, mean that you pay more interest as the mortgage will be spread over an extended period.
Interest-only mortgage:
Suppose a monthly payment is your concern, then look at interest-only mortgages. Interest-only mortgages are mortgages where you only service the interest, and the principal/capital amount remains at the end of the mortgage term. There are currently 55 banks and building societies offering interest-only mortgages. It will allow you to opt for a part, and part loan, where you can make some repayments of the capital balance, but your monthly payments remain substantially cheaper.
According to Goldman Sachs economists, a further 50 basis points increase is on its way in September, followed by a further 25 basis points rise in November and December of this year. It will take the BOE’s base rate to 2.75 per cent before the end of the year, which will only add further to the pressures on UK households. If your current deal ends soon, it will be wise to lock in a rate now to avoid a mortgage shock, as the only way for interest rates is up.
The opinions incorporated herein are given in good faith to share with the reader our knowledge and experience, but readers should make their own investigations and refer to other documents and should not rely solely on these blogs in any decisions they may make.