Another month, another rate increase from the Bank of England. At the end of June, it raised the base rate to 1.25%, taking it to the highest level in 13 years. Here, we look at what this means for those re-mortgaging at present, and also what pressure rising rates could exert on household finances.
What higher rates mean for those re-mortgaging Of those homeowners coming to the end of a fixed-rate deal and re-mortgaging right now, over half will face paying higher interest rates and therefore have higher mortgage bills.
Let’s start with the good news. Someone who was a first-time buyer who locked into a two-year fix in early 2020 is likely to see their mortgage repayments fall by £30 a month, or £360 a year, if they re-mortgage onto another two-year fixed deal at today’s rates.
This assumes they bought an average priced home with a 5% deposit on a 25-year mortgage term in early 2020, paying a 3.17% interest rate, equating to repayments of £1,080 a month. While rates on 95% loan-to-value (LTV) deals have risen since then, homeowners have grown their equity through a combination of house price growth and mortgage repayments.
As such, someone who bought with that 5% deposit two years ago is now sitting on 25% equity – 5% from their initial deposit, 17% from price growth and 3% from mortgage repayments. This means they can now access a 75% LTV mortgage product at a lower interest rate of 2.88%, thereby cutting their monthly repayments to £1,050.
Many people coming to the end of a five-year fix can also cut their mortgage payments when they re-mortgage now. The biggest savings are for a first-time buyer who purchased in 2017 with a 5% deposit. The equity in their home has grown to 34% and so they can qualify for a much cheaper deal, which means their monthly payments will reduce by £258, equating to a saving of £3,096 a year.
And now for the bad news. Most other homeowners coming to the end of a two-year deal are set to see their monthly mortgage repayments rise by 10%-17%. The biggest increase in cash terms is for those who bought initially with a 25% deposit – their equity has grown to 42%, but their mortgage rate has gone up from 1.42% to 2.81%. This pushes up their monthly repayments by £112, or £1,344 a year.
The pain threshold for rising rates
Further rate rises, which are widely expected over the coming months, will put even more pressure on households. We have tried to find the pain threshold for interest rate rises – looking back to see what the equivalent base rate would be in historic terms if the amount people borrowed (proportionately) remained the same.
At present, with the Bank rate just above 1%, an average first-time buyer with a 25-year repayment mortgage spends 36% of their income on their mortgage payments each month. At a 2.0% Bank rate, this rises to 40%, and at a 3.0% Bank rate, the first-time buyer will spend 45% of their income. This would put affordability back at levels equivalent to those of early 2006.
If the base rate hit 7.0%, homeowners would spend 66% of their income on mortgage repayments, squeezing affordability to a similar extent as on the eve of two significant market downturns: in late 1979, when the base rate hit 17.0%, and late 1989, when it stood at 14.9%. These calculations do not factor in any adjustment to house prices, although it is highly likely there would be a market correction if the base rate got even close to these levels.
However, while this is an extreme, the scale of house price growth and mortgage debt taken on by households means that fairly limited base rate rises by historical standards have the ability to add significant pressure onto household finances. Remember, too, that many borrowers have also never experienced a market without very low interest rates.
As a crude rule of thumb, a rate rise of 1.0% today exerts about twice the pressure on mortgaged household finances as the same rate rise would a decade ago.
