Could You Survive Payment Shock?

Interest rates are creeping up again, but what happens when your mortgage rate really soars? Could you cope with a 2% rise?

As was widely expected, the Bank of England has just lifted its base rate from 4.75% a year to 5%. This decision takes the base rate to a five-year high, with mortgage rates soon to rise in its wake. What's more, the money markets are pricing in another 0.25% hike in February, so there'll be more pain to come for borrowers!

Obviously, any mortgage borrowers who aren't on a fixed-rate deal (or possibly a capped rate) need to budget for higher monthly repayments in the months ahead. In particular, if you're paying your lender's standard variable rate (SVR, which is paid by all borrowers who don't have a special-rate deal), then the latest rate hike may lift it to around 7% a year.

Having reached a near-fifty-year low of 3.5% a year in July 2003, the base rate has crept up to 5%, thanks to the following rate changes:

As you can see, the Bank of England has taken a 'softly, softly' approach by only raising (or lowering) the base rate in 0.25% increments. Indeed, the last time that the Bank raised the base rate by a half-point (0.50%) was in February 1995, with the last half-point cut occurring in November 2001 after the 9/11 terrorist attacks in the US.

Nevertheless, anyone with a modest mortgage and a half-decent grasp of household budgeting should be able to take a few quarter-point rate rises in their stride. On the other hand, if you spend more than you earn, as millions of us do, or have a burdensome mortgage, then even a quarter-point rise forces you to tighten your belt and cut back!

Then again, what would happen if your rate suddenly took a huge leap upwards, for instance, when an attractive special-rate deal ends? In fact, more than a million homeowners who took out attractive fixed-rate deals three years ago face huge hikes in their monthly mortgage repayments as these deals expire. The same goes for borrowers with two-year fixed rates from 2004 which have already reverted, or will soon revert, to their lenders' SVRs.

Indeed, according to analysis from MoneyExpert, a typical fixed-rate mortgage in 2003 charged an annual interest rate of just 4.22%. After today's base-rate increase, the typical SVR charged by leading lenders will move to around 7%, which means a massive increase in monthly repayments.

For example, with a £100,000 interest-only mortgage, an interest rate of 4.22% means repayments of £352 a month. However, when this lovely low rate ends and an SVR of 7% kicks in, the monthly repayments increase to £583. This equates to extra interest of £2,780 a year, which is a rise of two-thirds (66%) and would blow a big hole in even the best-managed budgets!

Of course, the way to avoid this 'payment shock' is to make sure that you don't end up back on your lender's SVR when special-rate deals come to an end. So, if you have an attractive mortgage rate which is about to end soon, are fed up with paying extra interest to your lender, or need a loan to buy your first or next home, check out our mortgage service.

It's run by award-winning mortgage broker London & Country Mortgages, which searches the entire market (over eight thousand products) to find your ideal home loan. What's more, L&C negotiates special deals for its customers that you won't find anywhere else. The Fool's mortgage service is the perfect antidote to payment shock!

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