The looming interest rate rise: how it will affect you

Transcription

1 The looming interest rate rise: how it will affect you The longest period in living memory without a Bank of England rate rise is expected to end on Thursday, when the base rate is likely to increase by 0.25% to 0.5%. The percentage rise is small, but the worry for homebuyers with jumbo mortgages is that it could be the start of a number of increases that could make their loans unaffordable. However, for people with savings who have suffered near-invisible returns on their money, is this the light at the end of the tunnel? This week s GDP figures, showing a slightly better performance by the economy than anticipated, has made the likelihood of an interest rate rise on 2 November almost a slam dunk, according to City experts. About 80% of market watchers are saying an increase is inevitable, although there are voices calling for the Bank to maintain rates at their historic low.

2 Azad Zangana, an economist at Schroders, says: Despite the ongoing weakness in growth, it is hard to see why the Bank would change its policy bias now and not raise interest rates in November. The Bank argues that inflationary pressures could rise sharply if not checked by higher interest rates, and that the current low unemployment rate could lead to faster wage growth. So what will be the impact on households of a small, but momentous, change in interest rates? First-time buyers The average mortgage taken out by a first-time buyer is 136,000, according to the Council of Mortgage Lenders. But the majority have taken out two-, three- or five-year fixed-rate deals, so their payments will remain the same no matter what Bank governor Mark Carney says next Thursday. Even those who have a tracker loan linked to the Bank base rate will see their monthly costs rise by little more than a month unhelpful but hardly catastrophic. As a guide, the table (below) shows the impact of a 0.25% rise on a 2% tracker mortgage with a term of 30 years.

3 What is more of a worry for new buyers is the withdrawal of existing best-buy deals and their replacement by higher priced ones, as well as a big jump in the revert to rate at the end of two-year deals. Already, banks such as NatWest have repriced their deals upwards by as much as 0.9%, and expect more to follow once the rate hike is announced. The price of the average fixed-rate deal has started to step upwards for the first time in many years, although by only a tiny amount so far. The revert to rate is the shock that awaits most first-time buyers. For example, HSBC s two-year fix will revert to 3.69% at the end of the term. But once the base rate rises, that revert to rate will go up to 3.94%. So someone with a 136,000 mortgage will see their monthly payments jump from 503 today to 644. They will have to cross their fingers that there are cheaper loans available when they remortgage at the end of the deal. Existing homeowners The average mortgage of a home mover, say, a family trading up from a flat to a house, is 175,000, according to the CML. Many will have taken their loans out before the financial crisis and, if on a tracker deal, will see their monthly bill rise in line with the base rate hike. For example, Nationwide building society has just under 500,000 borrowers on its base mortgage rate of 2.25%, which will rise to 2.5%. Assuming the homeowner has a 25-year term, the monthly cost of a typical 175,000 Nationwide mortgage will rise by 22 a month, to 785 (see table). Nationally, 57% of homeowners are on fixed-rate deals, so only 43% are immediately affected by a rate rise. But if the Bank eventually increases rates to what many say will be the new normal of 3%, the average Nationwide 175,000 borrower is likely to be landed with a monthly bill of 1,023 or 260 more every month than what they are paying now. Should the base rate return to the pre-financial crisis levels of 5%, that borrower will have to find an extra 474 a month, although they are likely to have remortgaged to a better deal by then. And a base rate of 5% would throw the economy deep into recession. Jumbo mortgage holders For many homebuyers in or close to London, average mortgage sizes of 175,000 are meaningless. Many couples with professional jobs have taken on giant mortgages, often around 500,000. One in 14 borrowers have a mortgage in excess of 500,000 and a rise in rates will significantly impact their day-to-day finances. Even a 0.25% rise on a 500,000 mortgage increases the monthly cost by 53, or 643 over a year, says Paul Welch of broker Largemortgageloans.com. Though

4 many will be on fixed-rate deals, those will come to an end and the rate shock will be severe if the base rate continues to rise, as they have in the US, where interest rates have gone from 0.25% to 1.25%. If you average the interest rate between 1992 and 2006, it hovered around 5.5%, says Welch. In contrast, the average interest rate for the past 10 years has been just 1.27%. This has led to unrealistic asset values and a market which is overvalued. We re now seeing this start to correct itself in the most overvalued areas, namely London, but there still needs to be more correction. Advertisement I believe this will happen over the next decade as interest rates normalise and asset bubbles created by the artificially low interest rates correct themselves. Buy-to-let speculators The impact on buy to let will be more onerous as these loans are almost entirely interest-only rather than the repayment mortgages demanded of conventional homebuyers. A 0.25% increase in a 200,000 interest-only loan results in a 40 extra monthly cost compared with 25 extra on a repayment mortgage. If the base rate eventually goes to 3%, the monthly cost of many buy-to-let mortgages will more than double. The downside is that it could mean rent rises for tenants, although that will depend on local market conditions. Given the tax

5 increases that are coming through on buy to let, plus tighter lending criteria, further rate hikes may provoke amateur landlords to throw in the towel and sell up. Savers When the financial crisis hit in late 2007, the average Isa account paid an interest of 5.5% a year. So someone with 10,000 in a cash Isa was picking up gross interest of 550. By the middle of this year, Isa rates had fallen to record lows, paying 0.82% on average or 82 gross interest on 10,000 (see chart). Isa rates have already begun to creep up in anticipation of the Bank base rate rise. The average Isa account now pays 1.02%. Should that rise to 1.25%, our holder of a 10,000 Isa will see their income rise to 125 a year. Sadly, the experts say banks and building societies are unlikely to be offering much higher interest even if the base rate is raised. Rachel Springall at Moneyfacts.co.uk says: Any savers hoping a rate rise will significantly boost their returns would be wise not to jump the gun. While rates have been on the rise, it is largely down to the challenger banks, and there

6 is a more severed link between the base rate and savings rates these days, thanks to the government s lending initiatives. Until lenders start to compete for savers funds again, we are unlikely to see much improvement. The Guardian - Patrick Collinson - 28th October