While one member of the MPC voted to increase rates again at the last meeting, in general, expectations of when rates will rise have moved back. Rising wages seemed to signal the start of a return to normality and some predicted a rise in rates before the end of the year. The rise in sterling and low inflation pushed the balance in the other direction. Now China’s stumble has caused more worries, that if China’s economic fire burns less brightly, the rest of the world’s economies will be a degree or few cooler too. If China is no longer able to drive global growth, who will replace it? With Europe still in a fragile economic state, managing the UK deficit will become an even longer game. This swings the balance once again towards a later rate rise – most likely Q2 2016.
When rates do rise that will affect existing and new mortgage borrowers pockets and that message is getting through. Fixed rate lending is on the increase and took up 81 per cent of all gross advances in Q2 2015. But what is more interesting – and encouraging for a stable market - is the increase in the proportion of all loans that are on fixed rates. The proportion began to pick-up from 2013 as the cumulative effect of the fall in the cost of borrowing took effect.
The fact that borrowers chose fixed rates above variable rates - which were cheaper at the time -does show some forward thinking on their (or their brokers’) parts. When the take-up of fixed rates accelerated from the end of 2012, the minutes of the MPC revealed that it considered reducing rates below 0.5 per cent. That helped to subdue the pricing of fixed rate loans too so the take-up continued to rise. Forward action taken then should help the market remain stable when rates actually do rise.
There are currently about £1.2trn worth of outstanding mortgage balance, including buy-to-let and second charges. Of these 44 per cent, or £555bn, are on fixed rates, the majority of which will mature in two years or less and will be protected from the effect of any early rate rise. The remaining £700bn will however be affected straight away. So how much of a difference will this make?
A full-time working couple with two children who took out a fixed rate mortgage five years ago would on average have bought a house worth £162,500. Assuming an 85 per cent loan-to-value ratio at the prevailing fixed rate, they would have paid an annual mortgage payment of just under £9,500. After all of their outgoings on food, transport and utilities that left the household with about £2,200 a month to spend on everything else.
Taking the change in the cost of living and the small increases in salaries since then, conditions will have eased a little and the family would have about £2,400 left to play with after all of their essentials and mortgage payments. So how much would rates have to increase by before the family would face any significant payment shock? Research suggests that the mortgage rate would have to increase from the current variable rate of 2.2 per cent to 4.7 per cent. That is a full 250 basis points.
For a similar family who took out an average loan two years ago on the same LTV terms, but at the prevailing rate of 3.5 per cent, rates would only have to increase by 150 basis points to 3.7 per cent for them to be worse off. The difference is because of two things – the larger mortgage size due to more expensive property in 2013 than in 2010 and the fact that rates prevailing in 2013 were also lower than five years ago.
One hundred and fifty basis points is not that big an increase, especially because as the economy approaches an increase in interest rates, funds will become more expensive to rise on wholesale markets. In addition as the economy begins to improve lenders are likely to want to take the opportunity to restore some of their margin and they still have savers to think about. So it seems likely that those coming off two-year mortgages could face some payments shock. The size of that shock is, however, likely to be quite small – just £15 a month if rates were 1.5 percentage points higher.
That amount accelerates quite quickly, but there probably is not much to worry about in the short term. Realistically any increase in interest rates from the Bank of England will still be small and gradual and they will not rise all that far either. Several of the MPC members have already said that they expect interest rates to settle well below the historic average of 5 per cent and end up closer to 3 per cent. So the prospects for payment shock and a destabilisation of the housing market as a result seem quite small.
That said, tying onto a fixed rate loan that is affordable sooner rather than later is a sensible approach. Even if economic conditions suffer unexpectedly and cause the Bank of England to reduce rates further, it would be very difficult for banks and building societies to be able to adjust their rates because of their commitments to savers. So if the only way is up, make sure it is not going to be far.
Fionnuala Earley is residential research director of Hamptons International
Key points
Rising wages seemed to signal the start of a return to normality and some predicted a rise in rates before the end of the year.
A full-time working couple with two children who took out a fixed rate mortgage five years ago will only see a big hit if rates rise by 250 basis points
A family who took out an average loan two years ago at an 85 per cent LTV, would likely see a hit with a rise of 150 basis points
