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Rates will eventually rise: are borrowers prepared?

Written by: Paloma Kubiak
Speculation’s mounting that a base rate rise may be on the horizon. How will those who have only ever borrowed in a low rate environment fare?

The Bank of England’s Monetary Policy Committee was split in June whether to raise the base rate with a 5-3 vote in favour of keeping it at the historic low of 0.25%.

This glimmer of a rate rise was followed by governor Mark Carney stating that the “removal of monetary stimulus is likely to become necessary”, further fuelling the idea that the figure could move upwards.

Market expectations are volatile but currently suggest a first rise could be seen in 12 months.

A change in interest rates will see undoubtedly see winners and losers; beleaguered savers should benefit while borrowers will see an increase in their monthly repayments.

But a change won’t be enforced overnight – borrowers won’t see an immediate change to their mortgage payment, according to UK Finance.

Fixed rate borrowers

Its research suggests that over half of all outstanding regulated loans are currently on fixed rates, as is more than 80% of all new lending.

However, half of the 4.2 million regulated mortgage borrowers on fixed rates will come to the end of their deal this year or next. They can choose to go on to another deal, otherwise they’ll revert to their standard variable rate.

UK Finance said that for many of these borrowers, they’ll have enough equity to get a good deal, even if rates did increase moderately. The best rates are available to those borrowing a lower proportion of their property’s value, but it said rates are still “extremely low by historical standards even for higher loan-to-value (LTV) loans”.

Its data reveals that of the fixed rate mortgages due to expire and move to a reversion rate by the end of 2018, half have better than 60% LTV and so would, in principle, meet the LTV criteria for the best new deal rates. Another quarter have less than 75%, and almost all the rest are at less than 90%.

Variable rate borrowers

Around 3.9 million mortgages (regulated loans) are currently on a variable rate product and UK Finance suggests around 2 million SVR loans are older and smaller, taken out when house prices were lower.

But the typical borrower on an SVR, has a balance of £91,000, compared to £141,000 for those on fixed rates. The outstanding average interest rate for SVR loans is higher – 3.46%, compared to 2.88% for outstanding fixed rate loans.

The 1.4 million borrowers currently on tracker rate deals (almost all of which are Bank rate trackers) have higher average balances although, at £131,000, still lower than those on fixed rates. However, the average interest rate on outstanding tracker rate mortgages is 1.73%, considerably below typical rates for any other rate type.

Both SVR and tracker rate borrowers, have lower typical mortgage payments – currently £525 on average for an SVR customer, £566 for a borrower on a tracker rate and £741 for borrowers on fixed rates.

Based on the average balances above, a 1% rise in rates would add £76 in monthly mortgage payments for the typical outstanding SVR loan, and £109 for a tracker.

Affordability tests

Since the Financial Conduct Authority’s mortgage market review (MMR) rules came into force in April 2014, lenders are required to assess affordability by testing whether the borrower can afford the mortgage payments after deducting necessary expenditure from their household income.

UK Finance revealed that mortgages lent since 2015, 92% still outstanding were stress-tested for an interest rate at least 3% above their current interest rate.

‘Borrowers need to look at their finances to ensure they’re resilient’

James Tatch, analytics manager at UK Finance, said while borrowers are unlikely to welcome higher rates, most look well placed to withstand rate increases higher than anything that is likely over the next couple of years.

“We are in a world where many borrowers – including around 2.4 million who took out their first mortgage in the last 10 years – have never experienced an interest rate rise as a mortgage borrower. And while the vast majority of these will have come to the end of at least one deal rate, most will have then re-financed on to another deal reflecting the continuing ultra-low rate environment, or simply continued on an SVR which, in many cases, will itself be fairly attractive. Because of this, there is a risk of complacency – that some will not have factored this in to their financial planning.

“We do not have a crystal ball. But it is certain that rates will eventually rise and, if market expectations are right, sooner rather than later. When this happens, it is vital that borrowers are alive to the impact this will have on their own household finances.

“But ultimately borrowers still need to look at their own finances to ensure they are resilient as the era of rock-bottom rates unwinds.”

Tatch added that many borrowers will have other loans, savings or other investments, all of which are affected by rate rises, just as mortgages are.

“For those with high savings, the benefits may outweigh the additional mortgage costs. But for those with significant other borrowings, the reverse will be true,” he said.

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