Another month, and another letter from my mortgage lender arrives. The Bank of England’s decision to increase the base rate means the repayment on my tracker loan is inching up — again.
Am I bothered? Hardly. Opting for a lifetime tracker when I remortgaged my London flat in 2008 was one of the best financial decisions of my life.
When I first took it out, the interest rate was about 5 per cent, but soon it dropped like a stone to below 1 per cent. Instead of making lower monthly repayments, I stuck to the original level, then paid off bigger chunks as my pay increased.
The end result is that now, as rates are rising, I’m close to paying it off (the rate was so low, I slowed the overpayments some years ago to beef up my pension and Isa contributions instead).
I’ve benefited handsomely from interest rates staying “lower for longer”, but the prospect of rates getting “higher much sooner” raises all kinds of questions for our personal finances.
Investors are already braced for rapid rises in interest rates as central banks around the world battle higher inflation.
In the US, the Fed recently made its first rate rise since 2018, and is expected to make seven more increases this year (officials expect rates to be nudging 3 per cent by 2023).
In the UK, markets are pricing in rates rising to 2 per cent by the end of this year, though the Office for Budget Responsibility (OBR) has warned rates could hit 3.5 per cent next year if higher inflation persists.
In the race to get inflation under control, economists worry that rapid tightening risks sparking a recession and higher unemployment as businesses (and governments) absorb higher costs of borrowing.
All of this uncertainty is weighing on global equity and bond markets, and raises the unwelcome prospect of “stagflation” — higher inflation combined with slower economic growth.
This is challenging terrain for all investors, but especially those nearing retirement or who have already started drawing an income from their investments.
As discussed on the Money Clinic podcast this week, younger investors are concerned this could spell the end for the traditional 60:40 portfolio split between equities and bonds, and wary of the risks of taking on more equity exposure to expand their funds.
What rising rates will mean for UK property prices is (perhaps) more likely to come up in conversation at your next dinner party.
Considering double-digit house price growth, you might think rising interest rates would take some heat out of the market.
In a recent note, research group Capital Economics described property as the “weak link” as interest rates rise. Nevertheless, it predicted rates would have to get to around 4 per cent to trigger price falls, unless quantitative tightening causes a greater economic wobble than expected (rising unemployment would spook mortgage lenders much more than rising interest rates).
But what about the impact on the consumer economy? As someone with a variable-rate mortgage and rising monthly costs, I am very much in a minority.
Jason Napier, managing director of European banking research at UBS, says that fixed-rate loans now account for around 80 per cent of the UK’s £1.6tn mortgage market.
The fact that so many UK consumers are locked into low rate deals means “as the Bank of England raises rates, very little changes immediately for consumers”, he says.
Outstanding fixes are split pretty much 50:50 between two-year and five-year terms, so the “payment shock” of rolling off on to higher rates is very much a problem for tomorrow.
Even if you have a few years to go on your fix, consider how the OBR’s 3.5 per cent scenario could inflate your monthly repayments.
“The average interest rate on an outstanding mortgage in the UK is 2.1 per cent,” Napier says. “Based on a standard 25-year term, if interest rates went up 1 per cent, this would add around £100 to monthly repayments for every £100,000 you are borrowing.”
Napier feels the scale of rate rises markets currently anticipate is unlikely to push many households into default. Most borrowers will have been “stress tested” on rates of 5-6 per cent, which was the average mortgage rate when Northern Rock failed. But combined with other cost of living pressures, none of this bodes well for consumer spending.
If I had a bigger loan, I’d be scouring my mortgage paperwork to see what level of overpayments I could potentially make (these are often capped at 10 per cent of your outstanding balance per year).
Use a mortgage overpayment calculator to see the potential reductions you could make to your outstanding balance by the time your fix ends. When the time comes, the lower your loan to value, the better the rate you’ll be able to get.
And if the Bank of Mum and Dad has any spare funds, helping adult children with regular gifts from excess income could not only reduce the size of their mortgages, but also shrink future inheritance tax liability.
Changes to the base rate have a less immediate effect on the cost of short-term borrowing, but the record level of credit card spending has raised alarm bells.
It’s impossible to say how much of February’s £1.5bn spending spree — the highest monthly total since records began — is due to hard-up consumers borrowing to beat the rising cost of living or more affluent ones enjoying renewed freedoms.
I chatted to Chris Giles, the FT’s economics editor, who is of the view that both trends are happening at once. With standard bank overdraft rates of 40 per cent, should we be surprised that consumers see the typical 20 per cent charged on credit cards as a better deal?
It turned out we had both used our credit cards to book family holidays for later in the year (the twin attractions of enhanced consumer protection and loyalty points).
We are careful to pay off our monthly balances in full, thus avoiding interest charges, but not everyone can afford to do so — and zero per cent deals are getting much harder to come by.
Perhaps the only silver lining will be better rates of interest on cash savings accounts. For now, new entrant Chase is offering the market-leading rate of 1.5 per cent on account balances of up to £250,000.
This is welcome news for hard-pressed savers, but still nowhere near outpacing inflation which is expected to hit 8 per cent by the end of June.
Taking more risk and investing the money, paying down a chunk of your mortgage, or (dare I say it) spending it on a well-earned holiday may prove to be a better use of your cash.