Consumer Prices Index Factsheet
Consumer Prices Index Factsheet This factsheet tells you more about how the interest rate on Indexed Lifetime Mortgages from Hodge Lifetime operates, and gives you background information on the Consumer Prices Index (CPI). Products covered by this factsheet Indexed Lifetime Mortgage range IMPORTANT - For adviser use only: This factsheet is intended for professional advisers only. It provides general illustrative information only. It is not comprehensive and does not constitute any advice, recommendation, representation or commitment by us to any person and will be fully superseded by any contractual documentation. The information in it may change and become out of date. Each adviser and customer must always check for up to date information as it may differ from what is indicated in this factsheet. What is the CPI? Percentage changes to the CPI are the main measure of inflation in the UK. It is calculated and published monthly by the Office for National Statistics. It is determined through a detailed survey of the prices of a range of consumer goods and services. There are other variations of CPI which use a wider range of goods and services (especially the one which includes housing costs). What is the role of the CPI in the UK economy? The main objective of UK monetary policy is to deliver price stability. In other words, inflation that isn t too high or too low. Since 2003, the government has set a target for CPI inflation of 2% per annum. The Bank of England s Monetary Policy Committee is tasked with managing the UK economy in order to keep the actual level of CPI inflation close to the government target. If CPI inflation is higher or lower than the 2% target by more than one percentage point, the Governor of the Bank of England must write an open letter to the Chancellor explaining why inflation has increased or fallen to such an extent, and what the Bank of England proposes to do to ensure it comes back to the target. Where do we get CPI data from? The Office for National Statistics publishes the CPI, and the percentage change each month and various rates derived from the CPI. We use the All Items CPI Annual Rate in the manner indicated in this Factsheet. You can read its monthly publications here: www.ons.gov.uk/economy/inflationandpriceindices Why is the interest rate linked to the CPI Rate? CPI-linked funding sources sometimes have a ceiling and floor in place, and the benefits of the ceiling and floor can therefore be included in the Indexed Lifetime Mortgage which means that these aspects comply with the Equity Release Council s SHIP Standards. What is the ceiling and floor applying to the interest rate? All Hodge Lifetime s Indexed Lifetime Mortgages include a ceiling and a floor on the interest rate. A ceiling means that the interest rate will not go above a maximum ceiling level. The ceiling on the Indexed Lifetime Mortgage will be set out in the KFI (or, if applicable, mortgage offer). The ceiling will not change for the duration of the loan. The margin should be deducted from this amount to determine the highest level that the CPI Rate can rise to, before the ceiling takes effect. If, for example, the ceiling is 8% per annum and the margin is 3% per annum, then the Indexed Lifetime Mortgage will not be exposed to the CPI Rate above 5% per annum. A floor means that the interest rate will not go below a minimum floor level. The floor on the Indexed Lifetime Mortgage is set out in the KFI (or, if applicable, mortgage offer). The floor will not change for the duration of the loan. The margin should be deducted from this amount to determine the lowest level that the CPI Rate can fall to, before the floor takes effect. If, for example, the floor is 3% per annum and the margin is 3% per annum, then the Indexed Lifetime Mortgage will not benefit from falls in the CPI Rate below 0% per annum. How is the interest rate on the loan set? The interest rate is made up of two components: the All Items CPI Annual Rate as most recently reset as explained below (referred to as the CPI Rate in this factsheet); plus a margin, which is fixed for the duration of the loan. The interest rate is reset annually: The CPI Rate is adjusted from and including 1st April each year to equal the All Items CPI Annual Rate published in the preceding October (being the annual rate covering the 12 months ending in September).
Illustrative example of the annual resetting: The following table illustrates the interest rate in more detail in the 5 year period from 1 April 2012 to 31 March 2017, assuming an Indexed Lifetime Mortgage with an interest rate of the CPI Rate plus a margin of 3.0% per annum, with a ceiling at 8.0% per annum and a floor at 3.0% per annum. 12 months ending in Sept (published in Oct) CPI Rate (i.e. All Items CPI Annual Rate) Loan margin Loan interest rate (i.e. CPI Rate plus margin) Applied as interest rate on the loan from/to: Sept 2011 5.2% 3% 8.0% (ceiling) 1 Apr 2012 31 Mar 2013 Sept 2012 2.2% 3% 5.2% 1 Apr 2013 31 Mar 2014 Sept 2013 2.7% 3% 5.7% 1 Apr 2014 31 Mar 2015 Sept 2014 1.2% 3% 4.2% 1 Apr 2015 31 Mar 2016 Sept 2015-0.1% 3% 3.0% (floor) 1 Apr 2016 31 Mar 2017 Sept 2016 1.0% 3% 4.0% 1 Apr 2017 31 Mar 2018 In the above example with the margin set at 3.0% per annum, the ceiling of 8.0% per annum protects the borrower if and while the CPI Rate exceeds 5.0% per annum, but if and while the CPI Rate is below 0% per annum the floor of 3.0% per annum means that the borrower will not benefit from the lower CPI Rates. What level has CPI been historically? Measurement of the CPI data series started in 1996. The ONS has also estimated CPI back to 1989. The graph below shows the level of the CPI since the records began in 1996 as well as the estimated CPI from 1989 to 1996. 9 8 7 6 5 4 3 CPI CPI 5% CPI target 2% CPI 0% 2 1 0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
The average value of CPI (as at October each year) (a) across the 27 year period from 1989 to 2016 is 2.6% per annum (b) across the 20 year period from 1995 to 2015 is 2% per annum, and (c) across the 10 year period from 2005 to 2015 is 2.4% per annum. Prior to the introduction of the CPI, the Retail Prices Index (RPI) was used to measure inflation in UK. The ceiling in the Indexed Lifetime Mortgage protects borrowers during periods of high inflation. How much would be repayable at the end of the mortgage term? For variable rate loans, it is impossible to predict precisely how much will be owed at the end of the mortgage term. For illustrative purposes, a number of theoretical scenarios are set out below. You and your customer need to identify your own scenarios and carry out your own analysis relevant to each customer s personal circumstances and attitude to risk. All of these scenarios are based on an initial advance of 100,000 over a mortgage term of 20 years and: in the case of scenario A: a product with a fixed rate of 5.5% per annum for the duration of the loan; in the case of each other scenario: an Indexed Lifetime Mortgage with a variable CPI linked rate plus a margin of 3% per annum, with an 8% per annum ceiling and a 3% per annum floor. Scenario Description A Fixed rate of 5.5% per annum throughout the mortgage term B CPI Rate remains at the government target level of 2% per annum throughout the mortgage term C CPI Rate remains at 5% per annum throughout the mortgage term (so the interest rate is capped at the ceiling of 8% per annum) D CPI Rate remains at 0% per annum throughout the mortgage term (so the interest rate is floored at 3% per annum) E CPI Rate remains at 2% per annum throughout the first 15 years of the mortgage term, and is then 5% per annum for the final 5 years of the mortgage term F CPI Rate remains at 1% per annum throughout the first 5 years of the mortgage term, then 2% per annum throughout the next 5 years of the mortgage term and 3% per annum throughout the last 10 years of the mortgage term G CPI Rate remains at 2% per annum throughout the first 5 years of the mortgage term, 3% per annum throughout the next 5 years of the mortgage term and 4% per annum throughout the last 10 years of the mortgage term 466,096 335,980 291,776 265,330 305,462 278,081 180,611 A B C D E F G
Get in touch Freephone: 0800 731 4076 Hodge Lifetime, One Central Square, Cardiff, CF10 1FS www.hodgelifetime.co.uk Hodge Lifetime is a trading name of Julian Hodge Bank Limited which is registered in England and Wales (No. 743437). It is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Its registered office is One Central Square, Cardiff, CF10 1FS. 5A1-01 Apr17