Sunday, November 24, 2013

Housing Market - The Harsh Reality of Interest Rate Rises

Although interest rates are unlikely to rise before 2015, those entering the housing market in particular, should be conscious of imminent interest rate increases and ensure that they budget accordingly

On 13th October 2013 Bank of England Governor, Mark Carney, indicated that interest rates may rise in 2015, a year earlier than expected due to an improving economy and a significant fall in unemployment.  Although the announcement also indicated that interest rates are likely to remain low for several years, it is likely to have raised alarm bells for those who have variable rate mortgages as well as those who are thinking about moving onto the property ladder for the first time.

Over recent years mortgage borrowers have been spoilt by a record low base rate of just 0.5%.  Although the property market has suffered with the economy, we have had the opportunity to borrow money very cheaply for many years. Those who have taken this opportunity may have been lulled into a false sense of security, hoping that this will last for the vast duration of their mortgage loan!  In reality however, it is likely that those who have stretched their budgets or maybe those who are new to the property market will find any interest rate increase a major shock to their finances.

Even a small increase in interest rates will pose difficulties for many with variable rate mortgages, particularly those who have borrowed to their absolute maximum.  As an example the table below provides an indication of the financial impact of an interest rate increase on a variable rate 25 year repayment mortgage loan of £150,000, assuming and existing current interest rate of 3%:

Mortgage amount
Current Interest Rate
Interest Rate Increase
Existing Monthly Payment
New Monthly Payment
Increase per Month
Increase per Year

As can be noted above, for every 1% increase in interest rates on a £150,000 repayment mortgage loan there will be a nearly £1000 annual increase in repayments.  Add this to the fact that energy prices are soaring and in-fact have been predicted to rise for the next 17 years (see BBC News article), and in addition the cost of living – based on the consumer prices index – rose by 2.2% but pay packets have risen by just 0.7% on average in the past year’ as reported by The Mirror online on 12th November 2013, it is clear that many are likely to find themselves in financial difficulty over the coming years. 

The impact of progressive interest rate increases is starkly demonstrated by what happened in the early 1990’s. The extract below is from a recent article from Guardian Money website :
‘A sudden, sharp rise can have a massive impact on household finances, as Maureen Twiddy is all too aware. Maureen, 49, and husband Paul, 56, owned a house in Carlisle in the early 1990s when interest rates shot up to stratospheric levels. Our mortgage leaped from 6.5% to more than 15% in just 18 months. It was a nightmare and a real battle making our repayments every month. We were lucky to pull through, many others saw their properties repossessed'
The big difference between the early 1990’s and now is the value of property. The average house price in the early 1990’s was in or around £52,000 whereas at present this stands at just over £167,000 (Nationwide 2013).  Therefore the amount of money that is needed to borrow is substantially higher and so is the risk to both the borrower and the lender.  Obviously an interest rate increase will have a greater impact with the more money that is borrowed and nowadays the average debt is much larger based upon astronomic capital growth since the early 1990’s. 

The Guardian article above goes on to state: ‘Research by property analyst HML suggests that if rates increased from their current 0.5% to 1.75%, around 30,000 people would fall into arrears within a year. So it could well be time to review your finances and make sure you could cope'

Fixed rate mortgages provide a safety net in terms of financial certainty for a limited period of time, however WHEN interest rates start to increase, as a borrower is nearing the end of their fixed term, they are likely to find that new fixed rate term deals will not be as cheap as they once were.  As demand for fixed rate mortgage products starts to increase, lenders are likely to seize on the opportunity to make more money and increase costs for borrowers.

Over recent years the UK Government have been trying to breathe life into the UK Housing market to try to encourage growth and it appears that we are just starting to see signs of life, fuelled partly by the help to buy scheme.  Although interest rates are unlikely to rise before 2015, those entering the housing market in particular, should be conscious of future interest rate increases and ensure that they budget accordingly.  When interest rates start to increase (and this is only a matter of time), it is likely that the financial burden will prove too great for many.  Sadly, I suspect we will see a sharp increase in re-possessions as lenders start to reduce their burden against potential loss.

For those with a mortgage, whether repayment or fixed rate it would be wise to consider your options now rather than wait for interest rates to start to rise.  You may find that you already have a good deal, however there is no harm and no cost in looking around to see what is available.  Although there is no certainty in life, we can be fairly certain that interest rates will increase in the near future, which allows us to make provision for this in our finances. 

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