With last month’s interest rate increase bringing the BoE’s base rate to its highest level since March 2009, Natalie Thomas investigates what this could spell for the market and the future of mortgage rates.
The Bank of England’s interest rate may be at its highest level in almost a decade but the resounding message from the market is ‘keep calm and carry on’. August’s 0.25 per cent increase is the second rise by the BoE in just nine months, following on from its 0.25 per cent hike in November. Commentators may not be panicking just yet, but what does the latest increase signal for the future of affordability and cheap mortgage rates?
The current 0.75 per cent interest rate may be at its highest level since March 2009 but it is still relatively low compared to a rate of 5.75 per cent, which the market experienced in July 2007, so most borrowers should have no need to panic. Or should they?
UK Finance estimates that borrowers on a Bank Rate tracker will see their monthly payments increase by about £20 per month per £100,000 of mortgage. This could mean higher costs for just under half of all borrowers – around 3.9 million of whom are on a variable rate product, two million of which are SVRs.
At the time of writing, just under half of all lenders had increased their SVR as a result of the rate rise. However, according to UK Finance, around 95 per cent of new loans are now on fixed rates, with almost two thirds of first-time buyers opting for two-year fixed rate products over the past 12 months.
So, are borrowers well placed to handle the increase?
Atom Bank director of digital mortgages Maria Harris says given how stringent affordability checks have become recently, she would expect most people on mainstream SVRs to be in a good place to absorb a quarter of a per cent uplift. “I would be more worried about customers who are on older or more specialist SVRs which could be higher and [on which] borrowers may not have the same headroom in their affordability,” she says.
UK Finance estimates there are around 1.1 million borrowers who are on variable rates but who took out mortgages before regulation was introduced in 2004. Such borrowers have an average outstanding balance of around £80,000, it says.
Borrowers could also encounter problems around unsecured debt, says Pepper Money’s sales director Rob Barnard. “While most mortgage rates are fixed, the rates on unsecured debt often are not; this could be the area where interest rate rises really start to bite, as consumers now have more unsecured debt than ever,” he says.
“As the cost of servicing unsecured commitments increases, brokers could therefore see more demand for debt consolidation remortgages as borrowers look to lower their monthly outgoings by shifting unsecured balances onto a lower rate.”
So, what does the rate rise mean for future mortgage rates?
UK Finance’s director of mortgages Jackie Bennett has played down the impact the increase will have on the cost to lenders’ funds. “Lenders have individual funding models, with the cost and mix of funding sources varying considerably from lender to lender. As a result, when costing their SVR or reversion rates, lenders are not necessarily led by the BoE base rate, so any increase or decrease in the rate may not be passed on to borrowers,” she says.
One indicator of where rates may go is swap rates, which have gradually been increasing over the past two years, as has the London Interbank Offered Rate. Two-year swap rates were around 1.064 per cent in July 2018 compared to 0.908 per cent in January 2018 and just 0.48 per cent in July 2016.
Ten-year swap rates have not seen such strong increases, moving from around 1.493 per cent in January 2018 to around 1.545 in July 2018. Harris says despite the increase in swap rate, lenders’ rates have remained pretty low.
But she says: “If swap rates continue to go up, then fixed rates are likely to increase.”
August’s rise was expected and there is a sense that most lenders have adjusted their pricing. Moneyfacts.co.uk finance expert Sophie Hockenhull says borrowers were already experiencing increases to rates prior to the base rate announcement. It expects fixed and variable rates to rise further.
But she says: “Providers appear to be a lot slower to announce changes than with the previous rate changes in November.”
According to its figures, fixed rates rose by an average of 0.29 per cent in Q4 of 2017 – a 10.2 per cent increase – while 10-year fixed rates had increased by just 0.09 per cent by Q1 2018 – a three per cent increase. “As the fixed term increases, the rates are less responsive to anticipation of base rate,” she says. “It’s not always a base rate rise which increases rates but more the anticipation of the rise itself.”
John Charcol senior technical manager Ray Boulger says the pricing of long-term fixed rates are usually a good indicator of where the market expects the interest rate to peak and how long it will take to get there. He says that although fixed-rate mortgage pricing has changed little following August’s increase, there are some short-term consequences for borrowers. “Because the BoE’s Financial Policy Committee requires lenders to stress test affordability on the basis of a three per cent increase in the revert to rate, the majority of mortgage offers will now be based on a rate 0.25 per cent higher than previously, thus reducing the maximum loan,” he says.
Competition is key
Lenders may be facing rising interest and swap rates but there is one thing to ensure the market is kept alive – competition.
Connect for Intermediaries chief executive officer Liz Syms says: “Many fixed rates are not as low as they have been, but in historic terms they are still incredibly low for people with a reasonable loan-to-value.”
Association of Mortgage Intermediaries chief executive Robert Sinclair says banks who have gone through the ringfencing process have £50bn of surplus cash sitting on the balance sheet and will be looking to the mortgage market. “The market is seeing great competition for price around lower LTV mortgages for people who have good credit scores,” he says.
Phoebus Software Ltd sales and marketing director Richard Pike says the remortgage market may now be open to more borrowers than it once was. “For those who are mortgage prisoners as they don’t have enough equity or don’t fit the risk profile for a new lender, many existing lenders have agreed to look at product transfers,” he says.
A strong appetite from lenders should ensure any future increases do not spell the end to competitive rates. The market has spent the last several years recovering from the financial crash and is in good shape to handle any curveballs that may come its way.
When will the interest rate rise again?
Bank of England governor Mark Carney has said that any future increases in the interest rate are likely to be at a “gradual pace” and to a “limited extent”, but what do those in the market think?
Ed Stansfield, chief property economist, Capital Economics
“Rates could well be raised by another 0.25 per cent in October or November if the economic data continues to strengthen, but it seems more likely that the Monetary Policy Committee will wait until the outcome of the Brexit negotiations is a little clearer before it raises rates again – probably by another 0.25 per cent in May 2019.”
Robert Sinclair, chief executive, Association of Mortgage Intermediaries
“I believe the only reason the BoE has increased the interest rate now is so it has the capacity to cut it again next March if we do not see a smooth transition out of Europe. If we do experience a relatively smooth transition, I would expect the base rate to be one per cent in 12 months’ time and stay there, with the possibility of an increase in either November or March.”
Richard Pike, sales and marketing director, Phoebus Software Ltd
“If the economy stays on the same slow but steady growth path, it is likely there may be a rate rise within the next year, but with Brexit just around the corner and the prospect of there being no deal, it really is too uncertain to call. If we end up with no deal and the economy takes a nose dive, rates are just as likely to fall again as they are to rise.”
Ray Boulger, senior mortgage technical manager, John Charcol
“With the uncertainty Brexit creates and no indication that the very low unemployment rate is resulting in excessive wage inflation, combined with the risk that President Trump’s trade war will damage the world economy, I think the odds are that the next increase in the base rate is at least a year away.”
Andrew Gall, chief economist, Building Societies Association
“The general market view is that the base rate will rise to around 1.1 per cent over the next three years, so interest rates will still remain low relative to their historic averages.”
Sophie Hockenhull, finance expert, Moneyfacts.co.uk
“It is difficult to predict how much the mortgage rates will increase in the next 12 months; however, we expect to see a base rate increase every year by at least a quarter point for the foreseeable future.”