How the predicted increase in base rate will affect the mortgage market
26 June 2018
25 October 2018
Numerous commentators are predicting that we are about to enter a formal rate-rise cycle, so the days of cheaper borrowing may well be numbered for the foreseeable future.
If - or more likely when - rates do start to rise, it will be a period of potentially uncomfortable transition for many people, as they learn how to cope with higher monthly outgoings. There is a real danger that this could lead to increased incidences of missed payments and particular financial stress for those experiencing a life event such as divorce or redundancy.
For those who have taken on credit in the last 10 years, a base rate above one per cent will take them into completely unknown territory.
However, the shock wave will probably end up being more of a ripple effect, as 62 per cent of all outstanding balances are on a fixed rate according to the Bank of England. Moreover, in the third quarter of last year, 89 per cent of all mortgages were taken on a fixed-rate basis. So the majority of mortgage holders are protected from any immediate adverse impact.
Factors affecting mortgage pricing
With the BoE term funding scheme - introduced in the wake of the decision to leave the EU - coming to an end, lenders are more likely to increase savings rates as demand for saver deposits grows. It is very likely therefore that this will influence mortgage pricing - as to cover those higher rates, lenders will have to make more profit, which will result in correspondingly higher mortgage rates.
At the same time, property prices are expected to keep falling back, so lenders may also start to price higher loan-to-value mortgages differently to those that are considered lower risk.
It represents a great opportunity for brokers to demonstrate their value by helping clients find the best mortgage deals. However, it is vital that they maintain an up-to-date knowledge of each individual lender’s parameters and products.
What will happen if rates go up?
Clearly, what happens to lenders' products and criteria remains to be seen, but from an adviser's point of view, little may change. Consumers seeking advice will still expect advisers to have relevant market knowledge and the ability to assess their situation and make suitable recommendations. The only difference could be that advisers will have more queries to deal with from concerned consumers.
Speculation about BoE base rate may have already prompted many existing and potential borrowers to seek/re-seek advice. This should be used as an opportunity by advisers to get in touch with their existing clients to ensure borrowers are aware of the potential changes, what it means for them and whether making any alterations to their mortgage would be worth exploring.
What impact will an increased base rate have on lender profitability?
This cannot be predicted with any certainty at the moment. Lenders' profits have been diminishing for some time due to record low interest rates. Additionally, their profitability has also been impacted upon by competition in the market, with existing lenders innovating and new specialist lenders entering the arena. The potential is clearly there though for lenders to increase margins if they have to.
There have already been some exciting innovations in the mortgage market of late, a great example of which are 'intergenerational' mortgages. A rate rise will only help to keep this trend going, as more first-time buyers may require help to get on the property ladder.
At the end of last year, lenders squeezed their margins as much as they possibly could to remain competitive and meet year-end targets. They could now be expected to make claw backs wherever possible.
What impact will an increased base rate have on the mortgage market?
A change in the base rate will prompt many consumers to seek advice. It is also a good opportunity for advisers to contact clients to ensure they continue to meet their needs.
What impact will this have on affordability calculations?
Affordability is likely to become tighter for consumers if the rate increases, because of stress tests. The importance of these, particularly regarding affordability, came to the fore after the introduction of the Mortgage Market Review (MMR) in April 2014.
Since then, lenders have been required to ensure that they assess a borrower's ability to repay a mortgage now, and in the future - taking the impact of potential future interest rates into account.
MMR requires lenders, when assessing affordability, to apply an interest rate stress test that assesses whether borrowers could still afford their mortgage if, at any point over the first five years of the loan, bank rate were to be three per cent higher than the prevailing rate at the beginning.
An exception to the above is that if a mortgage is fixed for five or more years, the pay rate can be used as the stress rate. Therefore, instead of using a stress rate of seven per cent for instance, lenders could choose to use a stress rate much lower than this.
For those taking out five-year, ten-year and potentially even longer fixed rates, there is a distinct possibility, stress tests could become much more lenient however.
If rates do increase...
The BoE is expected to move slowly. Nevertheless, each quarter-point hike would add a further £297 to annual average interest costs, which currently stand at an average of £3,625.
Regardless of how matters unfold, consumers clearly need to be aware of the prospect of more expensive rates and what it means for their individual circumstances. The mortgage market review (MMR) goes some way to alleviate concerns due to lender stress testing, but the public need to be prevented from becoming complacent after seven consecutive years or record low rates.
That need is particularly pertinent after a survey by lovemoney.com revealed that 47 per cent of people lied on their mortgage application in order to get it approved. How many would find their ability to repay compromised if rates were to increase?
It must be remembered too, that many borrowers will not have benefited from the MMR safeguards, having secured their borrowing before the rules came into force in 2014.