Interest rate rises will hit British households hard, say economists
The first rise in Bank Rate could be just months away. How will mortgage rates react, and what should borrowers do?
Mortgage borrowers have been rattled by fears that their interest rate may rise following indications from the Bank of England that the first increase in the official cost of borrowing is only months away. This is becoming a concern for current property owners and first timers, it is also a concern for self-builders who already have to consider structural warranties on new buildings before their mortgage is issued.
The rate at which lenders can access money to lend is the key to what they charge you. They usually get this money either from savers’ deposits or by borrowing from other banks on the money markets.
For fixed-rate mortgages, which are more popular when the cost of borrowing is about to rise, the key rate that determines what banks pay for their funds is called the “swap” rate. Swap rates react to expectations of future interest rates and inflation.
The other major factor is competition for mortgage business. Lenders have been competing fiercely to attract customers in order to meet their lending targets and this has helped to keep mortgage rates at record lows for much of the year.
It’s slightly different for tracker mortgages, which are less popular at the moment. Here, the key wholesale rate is “Libor”, which is currently a little above Bank Rate.
Barclays has increased the rate on its popular five-year mortgage from 2.39pc to 2.59pc. It also increased the rate on its market-leading 10-year loan from 2.99pc to 3.25pc.
Santander withdrew its popular 2.19pc five-year fix and increased the cost of a range of other deals, including two-year fixes, although only by 0.1 of a percentage point.
But amid these price rises other lenders, such as HSBC and Coventry, cut their rates last week in a bid to attract customers.
Economists broadly expect that Bank Rate will initially rise from 0.5pc to 0.75pc, and that subsequent increases will be slow and gradual.
So far, the swap rates that drive the cost of fixed-rate mortgages have not reacted to expectations of a rise in Bank Rate at the end of the year. In fact, they have edged down in the weeks since Mr Carney’s remarks on July 16.
Two-year swap rates fell from 1.05pc on July 15 to 0.98pc on July 29. Five-year swaps declined from 1.66pc to 1.54pc.
This suggests that markets are relaxed about a Bank Rate rise and had already factored it in to the cost of borrowing. As a result, mortgage rates are unlikely to jump.
Instead, fixed rates are expected to increase at only a moderate pace. Jonathan Harris, of broker Anderson Harris, said he expected two-year fixed rates to rise by 0.25-0.5 percentage points ahead of a Bank Rate rise, while five-year fixes would see a rise of around 0.5 percentage points.
The cost of longer-term fixes is likely to increase faster because lenders must factor in rising interest rates over the medium term.
One thing is fairly certain, however: the record low rates that have been on offer for most of this year is unlikely to fall any further. Borrowers who want to lock in a fixed-rate deal should re-mortgage sooner rather than later while rates are still very competitive.
David Hollingworth, of broker London & Country, said: “The deals on offer are still exceptionally good value, but there is unlikely to be any benefit to holding off if you’re thinking of re-mortgaging.”
The cost of new tracker mortgages could also rise a little over the coming months and, as they simply track the Bank Rate, borrowers will see an immediate increase in their repayments when official interest rates do rise.
It’s impossible to predict with any accuracy how mortgage rates will rise over the coming months. But a look at how lenders have reacted to interest rate speculation in the past can prove useful.
At the end of 2010 there was talk that rates would increase in early 2011. Swap rates moved up, as did the cost of mortgages.
Five-year swaps rose from around 2.5pc in early December to 3.25pc by mid-February 2011. The best five-year fixed rates moved up from around 3.99pc to 4.59pc.
So even though there was no actual change in Bank Rate, the expectation of a rise pushed rates up by around 0.6pc.
Mr Hollingworth said the best-case scenario was that lenders had already factored the first rate rise into their pricing and that mortgage costs therefore remained relatively stable. But if swap rates moved up significantly, lenders could be forced to push their prices up.
A spokesman for the independent action group Save Our Savers, Simon Rose, said: “Savers and pensioners would be delighted if interest rates were to rise in the near future. Many of them depend on their savings for their ability to survive, and they have been incredibly hard hit. But I think the Bank of England will delay putting up interest rates for as long as possible, and in the end we think they will be forced to raise them because the economy is growing too strongly.”