Inside the UK mortgage crisis and how interest rate rises will affect you

First-time buyers undoubtedly have it especially tough but the rates hike will affect everyone, writes James Moore

Homeowners whose mortgages directly track the base rate will see their monthly payments jump by around £47 on average as a result of Thursday’s rate hike from 4.5 per cent to 5 per cent (PA)

As Rishi Sunak and Jeremy Hunt rule out direct financial help for borrowers, here’s what the interest rate leap means for you.

What is happening to interest rates?

The Bank of England put its base rate up by 0.5 per cent at the latest meeting of the Monetary Policy Committee (MPC) to leave rates at 5 per cent, their highest level since April 2008. Banks use base rates both to set the prices they charge to borrowers and pay to depositors. So when base rates go up, their standard mortgage rates go up. Savers’ rates are also supposed to go up, but banks tend to be a lot slower to increase these. Does that mean banks are profiteering off the back of your mortgage misery? There is good evidence that they are. Their net interest margins – a measure of lenders’ profitability – have been rising of late.

Why is this happening?

Rates are being increased in an attempt to control inflation, which is the rate at which prices rise. This is because higher borrowing costs take the heat out of the economy. Consumers have less room to spend, forcing firms to keep their prices lower to tempt them to part with their money. People also have more of an incentive to save (again reducing spending). Inflation has, unfortunately, lately proven to be remarkably sticky.

How many more times will this happen?

Well, the City is currently betting that rates will peak at 6 per cent, which means either four more quarter-point rises or two more big half-point rises like the one the Bank imposed this time. However, some traders think they could reach as much as 6.25 per cent by the end of the year. This matters. Interest rate expectations influence the strength of the pound, for example. The expectation for future rates also governs what is known as the “interest rate swaps” market. Lenders use this to determine the price they are prepared to offer borrowers looking to lock in, or fix, the rate they pay for fixed-rate deals. The MPC often seeks to guide the markets one way or another. However, its most recent minutes contained no attempt to dampen down speculation of much higher rates. The City clearly fears that more pain is on the way. It’s most likely right.

When will mortgage rates go down?

That’s the big question and I’m afraid that it is an open question. Inflation is expected to start falling significantly throughout the summer. There have been signs that food price rises have, for example, started to slow and last year’s energy price spike will soon fall out of the inflation calculation now fuel prices are coming off their worst. However, the Bank will not act immediately for fear of encouraging the re-emergence of inflation. Some commentators think it could be a year before the MPC has the confidence to start cutting rates. The era of cheap money is well and truly over.

What are the different types of mortgages available in the UK?

Fixed-rate mortgages (see above) fix the rate you pay for a set amount of time; mostly over two, three or five years, although there are longer deals available. Right now, the latter look quite attractive. The average two-year fix per Moneyfacts is, for example, priced at 6.19 per per cent. For a five-year deal it’s a bit less at 5.83 per cent. But Nationwide has a competitive 10-year deal that can come in at less than 5 per cent, depending on how much you want to borrow. While a 10-year fix can be portable - allowing you to move without penalty – remember that the early repayment fees for such long-term deals like this can be very heavy, especially in the early years.

If you fail to remortgage at the end of your fix you typically end up on what lenders call their “standard variable rate”. This is something to be avoided as the average is now nearly 8 per cent. Base rate trackers are another type of home loan. They usually charge a little above base rates and move up and down with them. That might look scary given what rates are doing but remember, they are usually considerably cheaper than lenders’ SVR. Remember too: the bigger the deposit you have, the lower the rate you will be offered.

What is a 100 per cent mortgage?

These are loans that cover the entire cost of a home. They are typically taken out by first-time buyers who can’t afford a deposit. They are, however, usually very expensive. Choice is also strictly limited. Few lenders are keen to offer them because they are seen as risky.

What are my options if I’m on a tracker mortgage?

It all depends on the type of tracker you have. Trackers usually have a limited term before you have to remortgage and that can mean an early repayment fee if you want to escape. That might be unwise. Remember, too, even though their costs are rising, some are cheaper than today’s two-year fixes even with base rates at 5 per cent.

What are my options if I’m on a fixed rate?

If you took out a fix when interest rates were low and face having to remortgage, it’s going to hurt. Your monthly repayments will jump considerably. There are ways of reducing them but they all come with drawbacks. The first is simple: you can extend the term of your loan to, say, 30 or 35 years if your current mortgage is for 25. This means you will ultimately pay more for your home but it will reduce the monthly cost. Another popular option is to transfer to what’s known as an interest-only mortgage. The problem with these is you will need to have some means of paying off the loan’s capital at the end of the term, otherwise you face losing your home. You should be ready to switch back to a repayment mortgage as soon as rates allow and then you may need to “overpay” to ensure the capital is paid off.

What steps should I take if my mortgage deal is running out in the next six months?

The best thing you can do is speak to your lender. This might sound intimidating, even frightening, but it really is the right thing to do. A lender will sometimes allow you to “lock in” the price of a new product but switch to something better if deals improve. They can also advise on ways to reduce your repayments (see above). If you get into trouble, they are supposed to help. That could be through offering a payment holiday or forbearance. If this doesn’t happen, you should complain and then approach the Financial Services Ombudsman, which is free to use but lands the lender with a fee.

What options are open to first-time buyers and how will the current situation affect them?

First-time buyers undoubtedly have it tough. The most important thing to do is shop around. Make use of price comparison websites to find the best possible rate. Use several. Some may have better deals than others. Try speaking to a mortgage broker – they sometimes have deals that aren’t available to the rest of the market. Put down as big of a deposit as you can. As I said (see above) this can reduce your rate. Bargain hard when it comes to buying a home to reduce the price. Prices are currently falling, so that at least is in your favour, and estate agents say the actual sale price of homes is usually quite a bit less than the typical asking price. Oh, and by the way, good luck.