At the time of writing the Bank of England (BOE) has just announced a 0.5% increase in the base rate from 1.25% to 1.75%. A rise of 40%. Alarm bells are ringing as the BOE predicts CPI inflation will rise to 13% and there will be a long recession of more than 12 months. To me, this is the usual doom and gloom prediction of an organisation that ought to know better. The Bank of England along with many other global institutions has a long track record of getting its predictions wrong so I wouldn’t lose too much sleep over their latest forecasts.
Do I know what is going to happen next? Well of course not. I am a financial planner, not a clairvoyant! Could any of us predicted the Coronavirus pandemic three years ago, the Russian war in Ukraine 12 months ago or such high inflation and large rises in interest rates just six months ago? Well of course not. What I can do though is discuss the probability of future events occurring but not the timing of them based on past experience of similar situations.
What is more than likely going to happen is that inflation will continue to rise and the base rate will have to be increased quite a lot to bring it under control. It is the main way of reining in inflation because it slows down economic activity by reducing spending by both businesses and individuals. I recall inflation in the high 20% range at one stage in the seventies and the base rate reaching 17%. Do you think interest rates and inflation couldn’t reach such high levels again? Think again.
I am not predicting inflation and interest rates will reach the same giddy heights as in the seventies but you never know. What I do believe is that a significant hike in interest rates is on the cards. I wouldn’t be at all surprised to see the base rate reaching 5%-6% and maybe even 9%-10%. If interest rates do rise to this level, hopefully, inflation will start to fall within say 12-24 months in which case the base rate could be reduced by several percentage points. So short-term pain for long-term gain.
Some people, mostly younger people in my experience, believe the Bank of England wouldn’t do this because it would be ruinous for mortgage holders but it is something they have to do otherwise the consequences for all of us would be much worse and more prolonged. It’s a bit like taking that medicine you don’t like when you are ill but you take it anyway because you know it will make you feel better even though the taste is awful.
The good news is that the majority of property owners would be unaffected by a large increase in the base rate. Why is this? Well, approximately 50% of the UK population own property mortgage-free. Of the rest about a third have fixed interest rate mortgages. Worryingly that still leaves about a third of property owners in a precarious position with variable interest rate mortgages but all is not lost.
Most of such borrowers should be able to convert their variable rate mortgages to fixed-rate ones. I would suggest a term of at least 5 years for most people though I personally know some borrowers who have opted for 10-year fixed-rate mortgages. Fixed-rate mortgages aren’t right for everyone. They are ideal if you plan to not sell your property for the duration of the fixed rate term. If you have to repay your mortgage before the fixed rate period has expired it will result in early repayment penalties which can be large, especially for 10-year fixed-rate mortgages. They are also bad news if interest rates were to fall during the term but that seems highly unlikely as the base rate is still historically extremely low at 1.75% compared to its 300+ years record.
The average UK mortgage debt in 2021 was £137,934. The average price in March 2021 was £231,855. This was a 2% increase from March 2020. For simplicity let’s say the average mortgage today is £140,000 based on a property valuation of, say, £250,000. The standard variable rate currently is about 5%. A five-year fixed rate should be achievable at a rate of say 3%. So even before interest rates rise a saving of 2% or £2,800 p.a. (£140,000 x 2%) can be made. Over five years that represents a saving of £14,000 (5 x £2,800). A not inconsiderable amount.
If variable mortgage interest rates were to double to, say, 10% over the next 5 years then the annual saving would be 7% (10%-3%) on a five-year fixed rate mortgage compared to a variable rate one. A saving of £9,800 (£140,000 x 7%) could be made. This equates to a saving of £49,000 (£9,800 x 5) over five years. That is a considerable reduction in mortgage interest payments.
So if you do have a variable rate mortgage and you do not intend to sell your property for at least five years, do seriously consider converting your mortgage to a fixed rate one for at least 5 years. You know it makes sense.*
*Your home may be repossessed if you do not keep up repayments on your mortgage. The contents of this blog are for information purposes only and do not constitute individual advice. You should always seek professional advice from a specialist. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.