Following the news that the Bank of England (BoE) has raised interest rates to 3% – an increase of 0.75 percentage points – homeowners and buyers are concerned about how this may affect their mortgage repayment costs and prospects of securing a new mortgage product.
Although this most recent base rate rise was slightly lower than some predictions, it marks the single largest jump in over 30 years, with economists analysing whether this indicates a potential recession.
The central bank, which is responsible for controlling inflation and attempting to keep it at a steady 2% target set by the government, has responded to sustained inflationary economic pressures, coupled with a higher unemployment rate, which is causing the cost-of-living crisis so widely reported.
Today, I’ll cover some of the reasons behind the climbing base rate and how base rates may impact different types of mortgage financing.
Central Bank Base Rates and Inflation Explained
Inflation is a measurement that tracks how much the costs of everyday goods and services have risen compared to the previous year. As mentioned above, the governmental inflation target is 2% – a level at which the economy grows gradually, without any sudden pricing shocks where things like fuel, food and utilities become unaffordable if wages do not grow at the same speed.
Central banks like the Bank of England and its counterparts such as the Federal Reserve in the US control base rates, which lenders and financial markets use as the foundation for the interest rates they charge to consumers and businesses.
The basics are that banks and other institutions pay the base rate against their own borrowing, with a higher base rate inevitably meaning that lenders will increase their interest rate charges.
Inflation Rates in October 2022
In October, the annual inflation rate reached 11.1%, the highest rate seen in 41 years, prompting the BoE to raise base rates to try and encourage more people to save and to reduce borrowing given the high costs of interest, a measure thought to have a positive impact on reducing inflation.
While higher interest rates are rarely good news, the move is not intended to target borrowers or make it harder to purchase a property or remortgage. Instead, the BoE needs to get inflation under control to prevent the cost of living from soaring any higher.
A recession occurs when a country’s GDP contracts for multiple successive quarters, usually for two quarters or more. Recession is a serious challenge since it can cause disruption in financial markets, cause homes and buildings to fall in value, increase rates of unemployment and mean businesses struggle to sell products and services, causing further business closures and job losses.
What Do Higher Base Rates Mean for Mortgage Borrowing?
The impacts of higher interest charges very much depend on the type of mortgage product you currently have and whether you intend to buy a home in the near future or are due to reach the end of a fixed-term mortgage agreement and need to find the most affordable way to refinance.
Around 2.2 million households in the UK have a variable rate mortgage product. These mortgages will become more expensive as banks and mortgage lenders adjust the interest rate they charge against monthly borrowing in line with the higher BoE base rate.
Impacts of Higher Base Rates on Variable Mortgages
The effects will vary for those with discounted mortgage agreements and tracker mortgages:
- Tracker mortgages charge interest directly linked to the base rate. Mortgage borrowers paying an interest rate of 3% will now pay a 3.75% interest rate, assuming a bank adds the same 0.75% increase as reflected in the base rate. The outcome would mean a £150,000 repayment mortgage with a 20-year term will cost £58 per month more.
- Interest-only tracker mortgages will also become more expensive. However, the monthly repayment value will normally be lower than a capital repayment mortgage since the borrower only pays the interest element of their borrowing.
- Discounted mortgages charge an interest rated with a fixed percentage discount calculated against the standard interest rate. Some lenders may revise their mortgage products or withdraw some mortgage agreements from the market if they cannot continue to offer the same proportionate discount.
It is important to note that mortgage lenders have discretion about how they respond to base rate rises. Some will increase their interest charges by exactly 0.75%, others will apply higher increases, and others may not make any immediate changes.
Much relies on the Standard Variable Rate (SVR) already being charged and how the lender’s profitability and the viability of products are affected by the higher borrowing rates a bank will need to pay.
Please get in touch at any point if you are concerned about your mortgage costs, are unsure how your lender expects to adjust your repayments or need advice about coping with increases to your interest rates.
Can I Get a New Mortgage While Interest Rates Are High?
New mortgages for first-time buyers are undoubtedly harder to arrange during periods of high interest, primarily because the cost of borrowing is greater, making affordability assessments more challenging for applicants whose wages remain static.
That does not mean you cannot apply for a mortgage, refinance your current agreement, or switch to another lender – more competitive products are often available.
The average interest rate charged on a two-year fixed mortgage is around 6.65%, based on figures from late last month, reflecting a significant increase from a 4.74% average recorded in September. This average is now likely to rise again.
As an outcome, some, if not most lenders, may now revise the interest rates they are prepared to offer. These decisions will depend on how the lender anticipates interest rates will change in the months ahead, with some taking a more prudent stance.
According to the Nationwide monthly report, house prices have fallen slightly between September and October, with a drop of 0.9% in the average valuation. That could mean that a proportion of the extra cost of borrowing against a new mortgage product is offset slightly by a drop in the value of a home you may be considering buying.
As always, our independent mortgage experts can assist if you need help working out the best options to proceed with your property purchase – please contact us to arrange a good time to talk.
Interest Rate Rises and Fixed Rate Mortgages
Property owners with a fixed rate mortgage agreement will not see any immediate change to their mortgage costs since a fixed rate mortgage means the interest rate is ‘locked in’ for the agreed period, usually from two to five years, although potentially for longer.
The challenge may be for fixed-rate mortgages that are coming to an end, particularly those agreements entered into before interest rates began to spike, and for payers currently enjoying a low-interest rate.
In these scenarios, the financial impact of the higher interest rates may be considerable and make a big difference to the cost of monthly mortgage repayments.
I would, though, advise caution. Fixed-rate mortgages commonly include early settlement penalties, a charge levied by the lender if you choose to remortgage the product, or repay in full, before the fixed term ends.
Making sudden decisions may cost more than necessary, combining an early exit charge alongside ongoing higher interest costs.
During this period of uncertainty, Think Plutus can help evaluate all the options available to you, make informed judgements about the best solutions, and give yourself plenty of time to research the market rather than rushing to refinance at the last minute in the hopes that interest rates will have fallen in the interim.
Analysts and BoE Monetary Policy Committee members predict that the opposite will happen and interest rates will continue to rise.