With the UK facing rising living costs in 2022-23, it is understandable that people want to know what may happen to their largest monthly expense – the mortgage (or rent). Interest rates are especially important in shaping the nature of mortgage deals on the market. Yet they do not form the full picture. During the Covid pandemic in mid-2020, for instance, mortgages offering a 5% deposit nearly disappeared as lenders ran scared of borrowers defaulting on their payments during lockdown. In this article, our financial planners at Vesta Wealth in Cumbria and Teesside explain how interest rates work, how they affect mortgages (along with other factors) and how this can impact your financial plan.
How do interest rates work?
All high street banks have their own interest rates. Yet they largely gravitate around a similar range. This is because they follow the “base rate” set by the Bank of Engand (BoE), which determines the cost of borrowing for the UK government. A rise in the base rate therefore has a big impact on the economy. The state may face pressure to cut borrowing and reduce spending on public services (e.g. health and defence) to balance the books. It also means that your own bank will face pressure to raise their own borrowing costs.
Interest rates & mortgages
Higher interest rates can bring a benefit to savers if an interest rate rise is passed on to cash savings accounts. However, this is often outweighed by higher interest rates on their mortgage deals. This can make monthly repayments more expensive for the bank’s customers if they are on a variable-rate mortgage (e.g. a tracker product or standard variable rate – SVR- product). If interest rates fall, however, then borrowers may find their monthly mortgage also going down. Those with a fixed-rate mortgage should see their monthly payments remain steady until the deal expiry date (e.g. 2 years, 5 years or perhaps more).
As a general rule, the higher risk of lending money for banks, the higher the interest rates are likely to be on the market. The base rate has a big impact here. However, the UK’s wider economic health is an important influence. If repossession figures are high, for instance, then lenders may start cutting their 5% deposit deals. Unemployment statistics are also important, since higher rates may lead banks to be more nervous about lending to people who may lose their jobs later.
Implications for financial planning
A word on 5% mortgages. These products can be suitable for specific people who struggle to get onto the housing ladder. However, these deals are highly sensitive to interest rates and the wider property market. As events in mid-2020 show, they may be pulled by lenders if they become nervous about the economy. It may be wiser to aim for a minimum 10% deposit deal, which are more likely to remain on the market. A higher deposit also means a lower loan-to-value (LTV) ratio on your eventual mortgage, which helps you get a better interest rate. This can make your monthly repayments far more manageable – freeing up more income for you to save, invest and enjoy. Also, if interest rates rise when your fixed-rate deal expires, then you are more likely to afford a good deal.
Since interest rates have such a big impact on the mortgage market, it is worth examining the economic outlook once or twice a year with your financial planner to see how this may bear upon your mortgage. Presently, UK inflation is running at a 40-year high (10.1%) and is expected to rise further – possibly to 18% or more – in 2023. This is likely to put further pressure on the Bank of England (BoE) to raise interest rates further to try and “cool down” the economy. In which case, banks will very likely raise their mortgage rates even higher. As such, homeowners who are currently on a variable-rate deal face difficult decisions. Should you stay on your existing deal due to its advantages (e.g. flexibility) or should you move to a fixed-rate before interest rates go even higher? It may be helpful to discuss this with a financial planner, who can help you sift through the relevant information.
Make sure that your mortgage fits appropriately into your wider financial plan, in particular integrating with your strategy for short-term savings, pensions and financial protection. Your monthly mortgage will likely be your biggest monthly expense. So, it is important to make sure the payments are sustainable and do not undermine your other financial goals and priorities. Once you get a mortgage, consider whether life insurance could help provide your family with protection if you (or your partner) died prematurely. This will provide a much-needed lump sum in the event, helping surviving loved ones to remain financially-stable (even pay off the rest of the mortgage) in the months ahead.
Invitation
If you would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.