What an interest rate rise could mean for your mortgage
emember, remember the 4th of November. No, Bonfire Night isn’t taking place a day early next month. But, if you’re a homeowner with a mortgage, it’s still a date worth noting.
That’s because this is when we’ll next hear from the Bank of England (BoE) and its highly influential Monetary Policy Committee (MPC) in connection with interest rates.
Should the MPC’s nine members vote in favour to increase the Bank of England base rate in November – say by a quarter or a half of a percentage point – the decision would have an impact on the finances of savers and borrowers alike.
For example, an interest rate rise would push savings rates higher.
This would be good news for savers, especially those with cash in accounts that pay paltry returns. Rates of as little as 0.01% are not uncommon currently, even on deposits of £50,000 or more.
A rate rise, however, would be welcomed much less by anyone who’s borrowed money, especially homeowners with mortgages. That’s because commercial lenders all take their cue from movements in the base rate.
Record low rate
The MPC last met in September, when it voted unanimously to keep the interest rate at 0.1%, the record low level it reached at the start of the pandemic in 2020.
The UK’s interest rate trajectory had already been on a downward curve during the decade prior to Covid-19. Rates fell dramatically, from 5% to 0.5%, in the aftermath of the 2008 financial crisis. The rate halved again, from 0.5% to 0.25%, in the wake of the Brexit referendum in 2016.
However, after 18 months of the current rock bottom rate, the feeling around financial markets is that a rate rise could be in the offing, possibly this side of Christmas.
According to broker Hargreaves Lansdown, “rate rises are now priced into the market before the end of the year, as a result of a deluge of inflation warnings, plus hints from some of the BoE’s rate-setters”.
Rate rise ‘inevitable’
Commentators say concerns about inflation, currently standing at 3.1% – more than a percentage point above the BoE’s 2% target – along with positive figures around jobs, are also persuading the markets that a rate rise is inevitable.
Countering these fears are the UK’s sluggish growth figures. A new round of pandemic protection measures, if introduced this winter, would also go some way to easing rate rise concerns.
Assuming, however, that rates do head upwards, if not in November, but possibly when the MPC makes its final interest rate announcement of the year in mid-December, what does this mean for households with home loans?
Raising the base rate has a knock-on effect for the cost of home loans, making mortgage repayments more expensive.
Laura Suter, head of personal finance at broker AJ Bell, said: “While savers will welcome a rate rise from the BoE, anyone with a mortgage will ultimately see the rise filter through to their mortgage costs.”
Winkworth, one of London’s largest chain of estate agents, said: “Even a small rate increase can have a marked effect on mortgage repayments that track the base rate… it makes a big difference to people’s budgets.”
Combined with a recent spike in UK inflation, not to mention the current turbulence being felt in the UK’s energy market, the last thing mortgage customers need this winter is a more expensive home loan to service on top of big rises in utility bills, fuel prices and the cost of the weekly shop.
Finances at breaking point
The worry is that the combined effect could stretch household finances’ to breaking point.
Ms Suter said: “It depends what type of mortgage you have as to how much impact you’ll see. Mortgage rates have been low for a long time and some homeowners who have bought in the past few years have only experienced rock-bottom mortgage rates. A small shift from the BoE won’t send rates sky-high [but] homeowners do need to be prepared for increasing rates.”
Sarah Coles, personal finance analyst at Hargreaves Lansdown, said: “Most mortgage deals are fixed at the moment, so most homeowners will be protected until their arrangement expires. The problem is, at that point, customers can face a big jump in costs.
“If you’re on a variable rate deal, your rate is likely to increase with any BoE change. So, you may want to consider bagging a fixed deal before any changes kick in, and while there are bargains around. It’s worth lining up a deal sooner rather than later, because when banks are convinced rises are on the way, fixed mortgage rates will go up before any announcement.”
Shop around now
Mortgage customers with less than six months to run on a fixed deal can start shopping around for a new home loan now. That’s because lenders allow you to lock in a rate up to half a year in advance.
It’s also worth exploring how much a rate rise could affect your future payments. This provides you with some breathing space to plan for how you could stretch your budget to cover a bigger monthly payment, should one be needed when your present deal finishes.
To help you do this, we asked Hargreaves Lansdown to produce some figures reflecting how a rise in interest rates would affect typical mortgage repayments.
The example tables below show two scenarios, one for a typical variable rate mortgage and the other for a fixed rate arrangement.
On the up
We’ve assumed that the present 0.1% interest rate rises to 0.25% in December 2021 and then moves upwards again, to 0.5%, in early 2022.
The figures assume a mortgage with 20 years left to run for the average London house price of £495,000.
Table 1 assumes an average variable rate mortgage of 2.32%, while table 2 shows repayments based on an average fixed rate mortgage of 1.99%.
Both rates reflect the average rates on outstanding property stock. In other words, the rates homeowners currently have, rather than the average rates available on new loans.
From the figures, monthly mortgage payments could be as much as £88 per month higher next spring.
Ms Coles said: “The gradual rate of change might lull homeowners into a false sense of security, because it might not feel like too much of a stretch to find £33 more in the monthly budget. However, the cumulative effect of rate rises can be devastating and, in a few months, if your mortgage payments are £88 higher, life could be much more difficult financially.”
Table 1: example mortgage repayments, assumed variable rate of 2.32%
Current monthly mortgage payment/£
Monthly payment & increase/£ assuming 0.15 percentage point rise