Mortgage Rates Rise As Banks Struggle

Life's about to get harder for homeowners as mortgage lenders up their rates in response to the worldwide credit crunch!

As I explained on Monday in Great News From The Credit Crunch, the global turmoil in financial markets has created a welcome boost for savers. Lenders struggling to raise money for their short-term needs have increased interest rates on fixed-term savings accounts in order to get more money through their doors.

Worryingly, the same forces are at work in the mortgage markets, as lenders adjust their lending offers to take account of higher money-market interest rates and reduced market stability. Indeed, Abbey, the UK's second-largest mortgage lender, today announced that it is poised to increase the interest rates charged on its range of tracker mortgages by up to 0.2%.

Although roughly four out of five new mortgage borrowers (80%) opt for a fixed-rate mortgage, tracker mortgages are gaining in popularity. In particular, they are attractive to those people who believe that the Bank of England will reduce its base rate next year, thus bringing down monthly repayments on variable-rate mortgages.

Although existing Abbey borrowers will be unaffected, this news will mean steeper mortgage repayments for new Abbey customers. What's more, Abbey expects this trend (tightening credit conditions) to continue for some time, putting other lenders under similar pressure. Hence, mortgage re-pricing is unlikely to stop there, with other high-street lenders sure to follow in Abbey's footsteps.

It's worth pointing out that this is an unusual move for Abbey, as mortgage lenders usually adjust their variable rates solely in response to changes in the base rate. Nevertheless, Standard Life today announced that it is also adjusting its rates to cope with money-market pressures.

Despite five rate hikes by the Bank of England's Monetary Policy Committee since August 2006, taking the base rate from 4.50% a year to 5.75%, the UK housing market still shows some signs of strength. However, increases to the base rate, coupled with tighter lending restraints, will eventually start to bite as hard-pushed homeowners feel the strain.

What's more, house prices will also be under pressure from the higher interest rates on fixed-rate mortgages, which have risen throughout 2007. Indeed, mortgage borrowers coming off a fix taken out two or three years ago will see their monthly mortgage repayments shoot up as they move onto today's higher rates. In addition, massively higher arrangement fees on fixed-rate mortgages (nowadays, around £800 to £1,600 a time) allow lenders to promote attractive `headline' interest rates and, therefore, disguise the `true' cost of home loans.

Furthermore, as lenders seek to strengthen their risk profiles, borrowers on the margins of affordability will be turned away more frequently. Indeed, the UK's subprime lenders have already priced in higher arrears, defaults and repossessions by hiking their interest rates -- in some cases, by as much as 2.5% a year. Predictably, this will make `lending at the limits' even less viable and will scare off prospective borrowers.

Finally, I think it's time to face facts. The UK housing boom has been largely fuelled by a decade of cheap credit. As interest rates climb and lax lending is curbed, personal, company and government creditworthiness will fall, and our ability to service debt will be tested. In addition, the predicted collapse in City profits due to the credit crunch will cause mega-bonuses to be slashed, hitting high-end property prices in London and rippling throughout the South East.

Thus, in the years to come, I expect the UK housing market and the economy as a whole to be much weaker than they were in the Blair years of 1997 to 2007. Expect mortgage arrears and repossessions to rise steeply, along with personal bankruptcies and insolvencies. In my view, now is not a good time to borrow up to your eyeballs for any reason -- and that goes for buying your dream home, too!

More: Shave Thousands In Interest Off Your Home Loan | Britain's Cheapest Mortgages