Are you sitting on a mortgage timebomb?
How to get ahead of increased interest rates
The past month has seen an acceleration of the rise in mortgage interest rates, which was inevitable after the extended period of abnormally low mortgage rates we've experienced over the past ten years.
Fixed-rate mortgage rates are affected significantly by 5-year gilt rates. This is why lenders either withdrew or repriced upwards their fixed-rate loans when gilt yields spiked following the disastrous 'Mini-budget' in late September.
According to MoneyFacts, the average cost of a new 5-year fixed rate is about 6.5%, with most competitive deals nearer to 5.5% with a 15% deposit.
Since the appointment of Rishi Sunak as the new UK Prime Minister and Jeremy Hunt as chancellor, the yield on 5-year gilts has fallen back to below 4%. If the new government leadership gets a grip on the country's finances and delivers stability to financial markets, mortgage lenders will likely offer more and better-priced fixed-rate mortgages.
Whatever the outcome over the coming months, it's clear that mortgage interest rates will be much higher than we've all become accustomed to. I have no idea where rates will eventually settle, but 5% seems to be a reasonably likely outcome during 2023. If inflation falls faster and further, it may be lower, and vice versa.
Higher monthly repayments
Although most mortgages are now on fixed rates, millions of borrowers will see their current fixed rate end during 2023 and beyond. These borrowers can expect to see their monthly repayments rise once they renew their loan.
Let's look at a mortgage of £250,000, which is currently on a fixed rate of 2.5% with a remaining term of 22 years. Monthly repayments on this loan are currently £1,232.
If the new fixed rate is 5%, monthly repayments will rise by £331 to £1,563. If fixed rates go to 8%, which is possible but not probable, then monthly repayments will increase by £783 to £2,015.
It would be wise to update family spending plans NOW and assume that mortgage repayments are already based on a 5% interest rate. The difference could be saved in an instant-access savings account. That way, when the rise happens next year, borrowers will have adjusted to that higher spending, and it won't be a shock. The money built up in savings could be used to reduce the mortgage balance when remortgaging.
This means making immediate sacrifices NOW on discretionary spending like holidays, home improvements, socialising and cars. If it turns out that the fixed rate on next year's replacement mortgage deal is lower than 5%, then discretionary spending can be loosened up and the accumulated savings can be spent, invested or used to reduce the mortgage (see below).
A lower mortgage?
Most mortgage calculators will show you how much you can borrow based on a multiple of your income. Only Google shows you how much you can borrow based on the monthly repayments you can afford (search in Google ‘mortgage calculator by payment’, select the ‘maximum loan’ tab at the top, then enter your desired monthly repayment, interest rate and term).
The chart below shows how much you could borrow based on a monthly repayment of £1,232. This is the monthly repayment for a £250,000 mortgage at a 2.5% interest rate over 22 years.
At a 5% interest rate, the mortgage loan would need to reduce by £52,750 to £197,250, to maintain monthly repayments at £1,232. At an 8% interest rate, it would need to fall by £97,000 to £153,000, to keep repayments the same.
Knowing how much you'd need to reduce your mortgage to maintain current repayments at a higher rate will enable you to make more informed decisions now. This means weighing up how best to deploy savings, future financial windfalls and pay rises for when you eventually refinance your mortgage.
When times are tough, you must focus on what you can control. And to do that, you need to know the financial implications of rising interest rates on any debt.
So get ahead of the curve and determine now how your mortgage might change when it comes off its current low fixed-rate deal.
Plan for the worse and hope for the best.
Best of luck.
Jason