Opinion: rate hike is storing up mortgage trouble for later

This week's rate rise will have little effect on most homeowners right now, but many on fixed rates are storing up trouble for the future.

The decision to hike the Base Rate to 0.5% this week will have been greeted with a mixed response by borrowers.

Those on trackers will see their monthly repayments rise almost immediately, while those who locked into fixed-rate deals will finally start seeing the benefit of paying a slightly higher rate in return for security.

But not all fixed-rate borrowers are in the same boat, a point we'll get to later.

Proliferation of fixed-rate deals

While the threat of rate hikes to borrowers is obvious, Robert Gardner, chief economist at Nationwide, quite reasonably pointed out that it's not all bad:

“The proportion of borrowers directly impacted by a rate rise will be smaller than in the past, in part because the vast majority of new mortgages in recent years were extended on fixed interest rates."

The number of variable rate mortgages is currently around 40%, down from a peak of near 70% in 2001.

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So what’s the problem?

The issue is that a rate rise today may not affect any homeowners with fixed-rate mortgages, but some could face big problems in the near future.

While a fair number are on five- and 10-year deals, two-year fixes are by far the most popular mortgage deals  – and it's not hard to see why. The shortest deals attract the lowest rates  – staggeringly, some below even 1% – and people have duly flocked to them.

Without being alarmist, it's fair to say that homeowners on these deals could face a very different mortgage market when their deal ends. For starters, the hike we saw yesterday will surely see the cheapest deals being pulled from the market.

Weakening house prices and the prospect of further increases could see people’s monthly repayments leap at the end of their fixed-rate deal, and they only have a short period of time to build up their finances to shield against it.

Understanding your fixed-rate mortgage

The first problem these homeowners face is that the economy and housing market are likely to be very turbulent over the next two years as Brexit looms.

This means interest rates could be far higher when their two-year fixes expire.

Someone with a 25-year mortgage of £190,000 with a two-year fixed deal at 1.7% is currently repaying £778 a month.

If the best deal they can find when it is time to remortgage is 3%, they would see their monthly repayments soar by £123 to £901.

Secondly, weakening house prices could mean people with only a small amount of equity in their property haven’t repaid enough capital to push them into a higher loan-to-value (LTV) bracket which brings higher interest rates.

You could have put down a 10% deposit when you bought your home and then dutifully made capital and interest repayments for two years, but weakening house prices – and increasingly popular lengthy mortgage terms of 35 years, which minimise the amount of capital you repay each month – could mean people have built up very little additional equity in their home.

As a result, when it comes time to remortgage they could find they are still in the 90% or, if their house price falls, even the 95% LTV bracket, where some of the highest interest rates are found.

What can you do?

The smart move now could be to go for the longest fixed-rate mortgage you feel comfortable with – there are currently some excellent deals on five-year mortgages or you could decide to fix for a decade with a low-rate 10-year mortgage.

These long-term deals give borrowers the opportunity to lock in a low rate for long enough to ride out the worst of the Brexit uncertainty and shave thousands of pounds off the overall cost of repaying your mortgage.

Interest rates are still extremely low at the moment, so locking one in for as long as you can make sense, especially as increasing mortgage portability means that opting for a long-term rate no longer necessarily means you have to stay at the same property for the duration of the deal.

If you are already on a short-term fixed rate deal that's close to expiring, note that you can effectively reserve a new mortgage up to a couple of months in advance.

If you have a longer period to wait, check what exit penalties you might have to pay before you remortgage to a longer deal. It might be a painful hit now, but ditching that cheap short-term deal could actually be beneficial in the long-term.

Do what's right for you

The reason we wrote this article was not to create panic, but rather to point out a potential issue that few people seem to be talking about. It really isn't as simple as saying a fixed-rate deal equals safety.

People on shorter-term deals should be thinking about their next step now.

Are rates going to rocket in the next 12 to 24 months? Probably not. As we noted in our Base Rate explainer yesterday, analysts believe we will see one, perhaps two, rate hikes in 2018, which would likely mean a Base Rate of 1%.

That's not a massive leap, but throw in house price and economic uncertainty, and it's impossible to say what your mortgage options will be in even a year's time.

Some of you might believe things will improve, others might have no choice but to stick with their current deals given the extortionate exit fees they'll be hit with.

But what we do know for certain is that mortgage deals are currently cheap, and long-term security in a time of uncertainty is something that might be worth looking into.