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The Effect of Rising and Lowering Interest Rates on Mortgage Rates

Published on June 9, 2014 by Aude Seynt Martin in News, Property Investment

The variation in mortgage rates over the past few years has greatly contributed to the current dramatic economic situation within the Western world. If Banks had paid more attention to the ability of borrowers to meet the financial commitments of their mortgages, rather than the drive to make profits for shareholders, one could query whether the collapse would have been so bad!

In particular, the “almost financial collapse” of the banking world was largely accredited to the increase of mortgage rates at the time.

Banks were eager to lend money to buy properties, since at the outset, the interest rates for the mortgage were relatively low. Indeed mortgages of up to 150% of the purchase value of the house were, at times, granted by banks on the basis that property values would continue to rise which in turn, would ultimately support the over-extension of the initial mortgage value.

Mortgage repayments were stretched to the limit, even at the time that the mortgage was initially executed. The situation continued to deteriorate as interest rates started to climb; mortgagees just could not pay the interest bill, let alone any repayment towards the capital loan. As a result, banks were forced to repossess properties, bringing about a collapse in property values and a subsequent reduction in mortgage rates, as the mortgage business for the banks started to fall away.

What is the base rate?

The Base Rate is the prime rate of interest set by the Bank of England, which lends money to commercial banks who in turn lend and create mortgages, which enables customers to purchase property.

The Base Rate is generally considered to be the benchmark for all forms of monetary interest rates, whether these are mortgages, overdrafts or even Payday Loans!

What happens if the Bank of England decides to increase/decrease the Base Rate?

In theory, should the Bank of England decide to increase the Base Rate, then it follows that the interest attached to any mortgages will increase in proportion to the increase of the Base Rate.

The Bank of England, which is supposedly independent of the government interference or influence, is directly responsible for the flow of cash throughout the commercial world. Property prices have a great bearing on the economic situation of any country and certainly as far as the UK is concerned. Therefore should property prices rise at an ever increasing rate, the Bank of England is able to control the flow of mortgages by increasing the Base Rate. This in turn decreases the demand for property, resulting in a slowing down in the increase of property values.

Similarly, should be Base Rate be decreased, mortgages both commercial and private, become more affordable and as there would be more potential buyers, it follows that the principle of supply and demand would come into force. There is generally a shortage of houses within the UK at present and therefore with cheaper mortgages, the demand is greater for property and so values of property start to rise.

Once again however, should this situation arise, the principal of inflation comes into effect. Whilst the practice has been for many mortgagees to totally miscalculate their ability to repay the mortgage, even the slightest increase in the Base Rate and subsequent mortgage rate, can cause considerable pressure on the financial resources of the individual mortgagee..

During the period of “financial crisis” banks were granting mortgages with total disregard to the principles of inflation. Contributing to this factor was the fact that mortgages were being granted without any form of deposit, which in itself was essentially a violation of normal banking practices.

What occurred was that technically, a person could walk in off the street to a bank in order to obtain a mortgage for any type of property. Often, a deposit would not be required and virtually no enquiries were made by the bank to ascertain the potential mortgagee’s ability to repay both interest and loan capital.

Matters have changed considerably since the crisis. Banks are now demanding a minimum of 20% of the value of the property before they will even consider granting a mortgage. Furthermore, extensive checks are now being carried out, to ensure that a borrower is able to repay both interest and principal loan and that this ability to pay, under normal circumstances, will continue throughout the duration of the mortgage.

Not only do banks now require verified confirmation of an applicant’s income, they now are inclined to inspect the outgoings and every day expenses of a potential applicant in order to protect themselves against a mortgage falling into arrears.

Interest Rates Calculator

We cannot emphasise enough the sensibility of a potential mortgage applicant to satisfy themselves that they really can afford, both short-term and long-term, the repayments that would be necessary to fulfil those terms of any mortgage.

interest-rates-calculator

Interest rates calculator

Whilst the Base Rate is currently exceedingly low, 0.5%, it can often seem to an applicant that repayments would be easy to fulfil. They totally ignore the possibilities of an increase in the Base Rate and therefore fail to anticipate any subsequent increase in mortgage repayments that would be directly associated to the Base Rate.

It is therefore in an applicant’s interests in the first instance, to carefully examine their own individual outgoings over a particular twelve-month period and prepare a list. This should include, yet not be limited to the following:

  • General household running costs including food, electricity, telephone/broadband, TV programmes, gas and water.
  • Vehicle expenses – fuel, tax, tyres and repairs, insurance.
  • Property maintenance and possible improvements, which would include decorations, extensions and general wear and tear.
  • Children – apart from food, the cost of children can be extremely expensive. Not only do you have the provision of clothing but demands are often made for social media apparatus, bicycles and other essential “toys” for the modern child. Do not fail to consider the overall cost of these items over a period of time, as they can often result in the largest part of a household’s budget.
  • Student costs – dependent upon the age of children, this could incorporate uniforms, extracurricular activities and support for those children moving on to university.
  • Holidays – when there are 2 or more persons in the family, these can prove very expensive and whilst the inclination might be to consider not taking a holiday for a long period, human nature decrees that this restriction will not continue throughout the progress of time. Remember, as an applicant for a mortgage, you are projecting your outgoings for up to 10 years or more into the future.

The next task is to calculate the present cost of a mortgage and then allow for the potential increase in cost should the Base Rate alter in the future. However, it may be reasonable also to anticipate that there will be an increase in the household salaries or wages during this time.

Now it is possible for the individual to sit down and manually calculate the effect of an increase in mortgage rates throughout the anticipated period of the loan. Whilst there is a number of online mortgage calculators available, our own trial of these has indicated the calculator hosted by the Daily Telegraph Money website is amongst the easiest and most efficient.

The calculator will allow you to input a variety of criteria including the duration of mortgage, possible percentage increase in interest rates, along with a potential decrease in relation to the interest rates.

In the past, it has been the norm to apply for a mortgage of 25 years in duration. However due to the uncertainty of economic situations and coupled with the different types of mortgages available both now and in the future, we would suggest that you adopt a period of 10 years and allow an increase in interest rates up to 15% as has been experienced in the past.

By deducting anticipated outgoings from anticipated earnings, you can then determine the maximum costs that you might incur in relation to the specific value of a mortgage.

We cannot over emphasise the importance and advantages of fully carrying out this task. It can be quite astonishing to see how both the increase in the Base Rate from the Bank of England, coupled with the rate of inflation can sometimes have a devastating effect on mortgage repayment amounts.

What are the expectations in 2014 in relation to interest rates?

There is a variety of differing opinions as to the expectation for interest rates during the period 2014 – 15. It was initially anticipated that interest rates would be increased by the Bank of England in the early stages of 2014 but this has not proved to be the case.

The current Base Rate of 0.5% is an abnormally low and although it has existed for several years, the general opinion is that it will, by necessity, rise at some stage during 2014. The challenge is to determine whether this increase will be slow or fast. By slow, the experts mean a nominal increase every few months up until the end of the year and by fast, a larger rise at one particular point during the year.

As one can imagine, there are a number of different views as to what would be more beneficial to the country at large. Some say that a nominal increase every few months will permit the increase to be better assimilated by mortgagees. Others are of the view that a larger, one-off increase may very well be required to keep the property market in a stable condition.

The only consensus seems to be that towards the end of 2014 and the early months of 2015, The Base Rate will increase to either a minimum of 1.5% or a maximum of 2.0%. The world economic situation is far too volatile for economists to accurately project interest rates any more than 6 months in advance.

Is a Fixed Mortgage the Better Solution?

When mortgage lenders endeavour to calculate a reasonable Fixed Interest rate on mortgages, they have to consider any potential rises and the amount of the base rate in the years to come. It also goes without saying that as a commercial Institute, a bank must make a profit for its shareholders.

An examination of the current market trends would indicate a gradual small increase for interest rates on a fixed mortgage. This is due to the uncertainty of the Bank of England Base Rate over the forthcoming period and whilst the general consensus seems to be that there will inevitably be an increase, the question that causes concern is when and how much it will be.

Providing a fixed mortgage is agreed over a short period of say 5 years, it is deemed to be one of the best ways of obtaining an affordable mortgage in the short period. Interest rates, hence payment rate,s are fixed and can therefore accurately be taken into the overall calculations for a household budget.

By sticking to a short period of 5 years, the situation will undoubtedly have changed when the maturity on the mortgage will have been reached. This would then give a mortgagee the opportunity to look at the various options for a mortgage available at that time. It could be deemed that a longer term with a variable interest rate could be very attractive, yet on the other hand, another fixed mortgage with static interest rates over an agreed period of time, may be the right solution.

Interest rates on fixed mortgages are starting to increase and there is no doubt that this increase will continue over the foreseeable future. Needless to say therefore, if an applicant is considering a mortgage, it would be in their interests to make an early decision in order to secure the best terms presently available.

Concluding Remarks

Purchasing a house can be a very time-consuming and frustrating exercise. This can be more intense if you need to sell your existing property and have to act quickly to purchase your new one. We can help you sell your house and settle your current outstanding mortgage but even having identified your new property, there are still a few more important decisions to make.

Interest rates and mortgages, economic forecasts and banking in general, can be extremely confusing for the inexperienced mortgage applicant. Advice received from different mortgage providers is normally geared to the specific products they are prepared to offer and not necessarily the most beneficial to meet your needs! Remember, they need to make a profit and their representative often needs to secure a commission based only on individual sales!

You should take into careful consideration all the aspects mentioned above, as the wrong decision made in haste without the facts, could possibly be more dangerous to the individual than ascertaining all the relevant information, so that the right decision may be made.

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About the author
Aude Seynt MartinAude Seynt Martin is an ex French corporate lawyer with a Master Phil in Property Law. When she came to London, Aude gave up her career as a Lawyer to be involved in property. Having studied the market for more than two years and worked with very experienced landlords and professionals, Aude is now a Property Consultant, whose motivation is to come up with creative solutions to help overcome any property related situation.

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