Is your fixed rate mortgage deal coming to an end this year? Here's how to deal with the threat of payment shock.
You can't argue with the facts. Around 1.4 million of us have a fixed rate mortgage deal coming to an end this year. No question about that. But the more debatable issue is whether our finances will be able to withstand higher mortgage payments after our fixed rate has ended.
If you have a fixed rate deal that's on its last legs, I wouldn't be surprised if you're concerned. Some press articles have suggested that many borrowers will struggle to meet higher mortgage repayments when their fixed rate expires. This is what's known as `payment shock'.
One Million Borrowers At Risk
Figures from the Financial Services Authority (FSA) suggest as many as one million borrowers could be at risk of falling into arrears and are vulnerable to possible repossession of their homes.
These are really frightening numbers. Even just this week, a member of the Bank of England's Monetary Policy Committee warned that borrowers, particularly those who are deemed a greater credit risk, may have no choice but to move onto their lender's far more costly standard variable rate (SVR) once their fixed rate period ends.
Indeed, data from the FSA reveals borrowers in this position could be faced with a whopping £210 hike in monthly repayments on average by paying the SVR, which is the lender's bog standard - and therefore most expensive - mortgage rate.
But, amidst all this doom and gloom, the Council of Mortgage Lenders (CML) reckons payment shock may not be as bad as we first thought.
The CML estimates a borrower coming off a two-year fix and choosing a new tracker mortgage - where repayments vary in line with changes to the Bank of England base rate - will pay an extra £140 per month* if they re-mortgage during the first three months of the year. However, those moving their mortgage in the final three months of the year may experience a rise of just £39* if further base rate cuts filter through to lower mortgage rates.
What's more, the CML predicts first-time buyers will also find payment shock less, well, shocking. A typical first-time buyer who is coming off a two-year fix would find their monthly net salary has increased by £185 since the loan was initially taken out, putting potentially higher mortgage repayments within their reach.
Who's right? I don't know for sure.
But what really matters are your personal circumstances. If your finances couldn't cope with a hike in your repayments, then payment shock is a concern for you.
However, don't despair. There are steps you can take to reduce the impact:
Protect Yourself From Payment Shock
The first thing you should do it speak to your existing mortgage lender as soon as you can. Find out if re-financing your mortgage is likely to leave you with an uncompetitive deal. You may find things aren't as bad as you expect.
If your lender doesn't give you a satisfactory answer, then think about making yourself attractive to other lenders.
In the current credit climate, lenders may be put off by higher risk borrowers. That includes people with a high loan-to-value (LTV) which measures the outstanding mortgage debt as a percentage of the value of the home. So, think about getting your LTV down by overpaying your mortgage (if permitted by your lender).
And this doesn't have to be as expensive as it sounds. Take a look at the following example:
Mortgage Deal | Monthly Repayments | Loans Outstanding After Two Years | % LTV |
|---|---|---|---|
2 Year Fix at 5.5%: £100K over 25 years | £614 | £96,058 | 96% |
2 Year Fix at 5.5%: £100K over 25 years | £655 | £95,000 | 95% |
Standard Variable Rate at 8%: £96,058 over 23 years | £762 | N/A | N/A |
In this example, if you began with a 100% mortgage - that is, you had no deposit - but overpaid your mortgage by just £41 each month throughout the two-year fixed rate period, you'll have reduced the outstanding debt by a massive £5,000.
Crucially, this means your LTV will now only be 95%, which should open up more competitive mortgage deals to you. Lenders are becoming less keen to operate in the riskier higher LTV market, so the lower your LTV, the better. Ask an estate agent to value your property to give you a rough idea of your LTV.
If the end of your fix is fast approaching you may not have much time left to overpay monthly. You could try paying off a lump sum if your lender and your finances will allow.
If there's no spare cash and your lender's SVR looks like your only option, then appeal for an extension to your mortgage term to reduce your payments. Or ask if you can temporarily switch to an interest-only mortgage until your finances improve.
I think it's unlikely large numbers of borrowers will be forced onto the SVR in the absence of any better offers from their own or other lenders. As I discussed in What Does The Credit Crunch Mean For Re-Mortgagers? I still believe those of you with clean credit histories should be able to find a competitive mortgage after your fixed rate has disappeared.
Visit The Motley Fool's Mortgage Service to help you find the best possible deal.
*= Based on a typical £114,000 mortgage.
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