Online estate agency Tepilo takes a closer look at the impact of the Bank of England’s first interest rate rise in more than a decade.
It won’t have escaped many people’s attention that interest rates rose for the first time in over a decade last week.
The Bank of England’s Monetary Policy Committee opted to raise the base rate from a record low of 0.25% to 0.5% - partly because of better than expected economic growth and partly to offset the rise in inflation, which recently reached a five-year high of 3%.
The increase – the first since July 2007 – reverses the cut made in August 2016, when the MPC slashed rates to 0.25% in the wake of Brexit.
A rise in interest rates is generally seen as a boost for savers but less good news for households with mortgages. While savers may now see modest gains in their returns, nearly four million households face higher mortgage interest payments. Those on variable rate mortgages will be most affected by the Bank’s decision.
Interest rates: a brief reminder
Borrowers have enjoyed a long period of low borrowing costs and cheap mortgage deals, stretching back more than a decade. In the aftermath of the global financial crisis in 2007-8, the Bank of England decided to cut interest rates to (then) record lows of 0.5% to protect the economy.
Interest rates stayed at this level for seven years until Britain rocked the world by voting to leave the European Union in June 2016. A few months later interest rates were cut even further - to 0.25% - to protect and stimulate the economy.
Now, with GDP growth more resilient than expected – it rose by 0.4% rather than the predicted 0.3% in the third quarter – creeping inflation and worries about high levels of consumer debt, the Bank of England has decided to act.
Will they rise again?
According to Mark Carney, the governor of the Bank of England, the base rate is expected to rise twice more over the next three years.
The rises would be expected to be small and gradual – no more than 0.25% each time - which would mean a new base rate of 1% by 2020. The Bank of England would then like to get rates back to more normal levels, after a long period of record low rates, but few expect interest rates to rise above 3% in the foreseeable future.
Banks are likely to hand on the rate rise to savers, but most people with mortgages should not be affected immediately. The majority of households in the UK have opted for fixed-rate mortgages – where interest payments remain the same each month regardless of the base rate – which means it will take some time for the increase to have an impact on them. However, when their fixed-rate mortgages come to an end, borrowers could find themselves worse off when they come to remortgage.
Nearly 60% of homeowners are on fixed-rate deals – a legacy of the financial crisis and a desire from borrowers for more stability and security – while only approximately 30% of households in the UK actually have mortgages. The number of people affected by a base rate increase, then, is fairly small (relatively speaking).
Many borrowers, however, are on short-term two-year fixed rate deals, and when these deals expire their next is likely to be more expensive. Those who fail to remortgage in time would find themselves on their lender’s standard variable rate (SVR), which will now be more expensive and could give fixed-rate borrowers a payment shock.
The number of people affected immediately by the rate rise is now much lower than a decade ago, according to research by the Resolution Foundation. Just 11% of all UK households are likely to be impacted straightaway by the increase, in comparison to 19% in 2007. This is partly reflective of the fall in home ownership – which is decreasing year-on-year – and partly reflective of the number of people now on fixes.
Who will be affected?
Those on tracker or standard variable rate mortgages – 3.7 million-strong in the UK – would be most at risk of losing out. These mortgages typically track or move with the official bank base rate – when interest rates go down, repayments are cheaper. And vice versa.
According to analysis by UK Finance, the average outstanding balance on a mortgage is £89,000 and payments would increase by about £12 a month (or £144 a year). Nationwide has calculated that the average borrower with a variable rate mortgage will now see their interest payments rise by £180 a year. While not ideal, this is probably an extra cost that most households can absorb. If interest rates were to rise much higher – to, say, 3% - the impact would be far more noticeable. However, such a dramatic rise seems unlikely anytime soon.
What will happen to house prices?
It’s hard to tell for sure how house prices will be affected. While any rate rise tends to have a negative impact on the property market – bashing confidence in the short-term – the latest house price reports suggest solid growth. House prices rose by 0.4% in October, the most recent Nationwide house price index found, even at a time when an interest rate rise was heavily mooted.
It appears buyers have taken into account a rate rise when setting their budgets and many borrowers are fixing their mortgages for longer than in the past with the increase in mind. Many borrowers also rushed to remortgage before the rate rise was announced to secure a better deal before the period of ultra-low interest rates came to an end.
What about buy-to-let?
Nearly every landlord has an interest-only mortgage, which means a base rate rise has more of an impact on this demographic than those following a repayment model. Some buy-to-let landlords will face higher monthly costs as a result of the rise, but that is always the risk with an interest-only mortgage and part of the reason why they are much less common nowadays.
Overall, then, the number of people affected immediately is low, but further rate rises in the future would have a wider impact.