How changing rates affect your mortgage costs
What will rising interest rates mean for your mortgage and how can you protect yourself from increased costs? Our guide explains how interest rates work and what it means for you
LAST BANK OF ENGLAND UPDATE: SEPTEMBER 2022 The Bank Rate is 2.25% The last change to the Bank Rate was in September 2022, when the Bank of England increased the rate from 1.75% to 2.25%.
What is happening with interest rates in 2022?
It is the role of the Bank of England to set interest rates in the UK – known as the Bank Rate or sometimes the base rate. It’s one of the tools used to try to control inflation and the UK economy.
Any movement in the Bank Rate has an impact on the interest we earn on our savings – and it also affects the rate at which we can borrow on mortgages – as well as other forms of credit, such as credit cards and loans.
While the Bank of England base rate has been historically low for more than a decade – meaning people have enjoyed low borrowing costs – things are starting to change.
Interest rates have been very low since 2009 when they were cut to just 0.5% in reaction to the fallout of the financial crisis. They then remained low and reached a record low of 0.1% between March 2020 and December 2021 (to help the economy during the coronavirus pandemic).
But with inflation rapidly increasing, the Bank of England has started to push up the Bank Rate in a bid to curb it. The Bank Rate went up in December 2021 and then again in February 2022, March 2022, May 2022, August 2022 and September 2022. It is widely predicted that the movement in 2022 will continue upwards.
But how do interest rates work and how can you protect your monthly mortgage payments from going up?
What is an interest rate?
The interest rate set by the Bank of England (Bank Rate) is what other banks and building societies use to set their own lending (and savings) rates for customers. Interest is applied on products such as mortgages and loans - and this is sometimes referred to as the cost of borrowing.
The way mortgage interest works on your home loan will depend on the types of mortgage deal you have - for example a fixed rate or variable rate.
What is the Bank of England Bank Rate?
The Bank of England Bank Rate is controlled by the Monetary Policy Committee (MPC) – an independent group of economists working within the Bank of England.
It is their job to look at how the economy is performing and the level of inflation. They then make a decision on the base rate each month. This decision dictates the level of interest set by other banks and building societies in the UK and will impact on how much interest you pay on your mortgage or loans.
If the Bank of England decides to put up the Bank Rate, the aim is to get banks and lenders to also increase the rates they charge to borrowers and businesses – including the interest rate they charge on mortgages.
Why are interest rates rising?
The government's most recent rate hikes are intended to curb soaring inflation, which is being driven by the sky-high price of energy. This has doubled since May 2022, amid supply constraints caused by the war in Ukraine.
In more normal circumstances, a government's usual motive for hiking rates is usually to ensure consumers getting a better return on money they have squirreled away.
This in turn should encourage them to save, as opposed to spending. It should also encourage them to borrow less because loans (including mortgages) and credit are more expensive. This should also help to slow the rise in the cost of everyday goods.
How do interest rates affect my mortgage?
If interest rates rise, mortgages will become more expensive.
Lenders will typically pass on the increase in the Bank Rate to their customers in the form of higher monthly mortgage payments.
This will cost you more over the term of your mortgage.
If you are about to buy a home or remortgage, you might want to think about opting for a fixed-rate deal to lock into a lower rate for the next few years and sheild yourself from rising rates.
How will rising interest rates affect my mortgage?
If you’re on a tracker mortgage – a product which tracks the Bank of England’s Bank Rate – your mortgage rate will always increase in line with any rise in interest rates.
If you are on a variable mortgage deal, such as a discounted variable rate or standard variable rate, the rate may be influenced by a rise in the Bank of England Bank Rate – but it is also at the lender’s discretion. In some cases a lender may pass on a bigger rate increase to its variable mortgage rates, for example, or the rate increase could be less than the change to the Bank Rate.
What will happen to my mortgage payments in 2022?
If you’re on a fixed rate mortgage deal you won’t see any change in your rate or monthly payments until your deal ends. This is because you’ve agreed your rate for a set period of time. But once this fixed-rate deal finishes, you could find new fixed rate deals rates are much higher than when you last fixed.
If you’re on a tracker mortgage linked to the Bank Rate, your repayments will rise with any increase to the Bank of England rate – and so it’s possible your rate and payments will increase even further this year.
As a borrower, you need to be aware that even a small increase in the Bank Rate can translate into a significant increase in your monthly mortgage costs.
As a guide, if the Bank of England puts interest rates up by 0.5%, that would add £56 a month to a 25-year £200,000 mortgage for those on a tracker mortgage deal. Over a year, this would add up to £672.
The table below reveals how much incremental increases to a tracker mortgage rate can add to an average borrower’s monthly mortgage repayments. This is based on a £150,000 repayment mortgage over 25 years.
How can I protect myself from rising interest rates?
If you’re on a variable rate mortgage, the best way to protect yourself from rising rates is by moving to a fixed rate. In many cases, this is likely to be the sensible option as you can lock into a lower rate for two, three or even five years, for example – to suit your needs.
Typically the best fixed-rate deals are quickly withdrawn by lenders if there is the hint of an interest rate rise – so you need to act fast. But always tread carefully before making any move to check what fees might apply.
While you shouldn’t face early redemption penalties for leaving a standard variable rate mortgage, there could be an arrangement fee when moving to a new fixed rate deal. Also remember to factor in expenses such as valuation and conveyancing fees.
If you are currently on a fixed rate it pays to be prepared. If you’ve got less than six months to run, you can secure a new mortgage deal now in advance. Don’t wait for your deal to expire.
When choosing a new fixed rate mortgage, you might want to consider a longer-term fix of five – or even 10 years, for example. But beware of fixing for longer than you are comfortable with. It’s hard to predict what life will look like a decade from now – and there might be early exit penalties if you want to move house or restructure your loan within the fixed rate term.
Where can I get the best - cheapest - interest rate for my mortgage?
There is no one ‘best’ mortgage deal at any point in time. The best rate you can get will depend on your financial circumstances and the mortgage rates available at the time – and the Bank of England Bank Rate will have a big impact on this.
That said, lenders may choose to offer low rates from time to time in a bid to win new business. That’s why it’s so important to research carefully – shopping around to compare mortgages – both on rates and fees – to find the best product for your needs.
How can I keep my mortgage costs down?
There are several steps you can take to keep your mortgage costs as low and affordable as possible.
If you’re a first time buyer, one of the best things to do is save up as much towards your cash deposit as possible. This will mean you need to borrow less on a mortgage and you’ll have a lower loan-to-value (LTV). With a lower LTV, you’ll be able to access more competitive interest rates.
If you’re remortgaging (switching to a new mortgage deal) and now have a lower LTV than previously, this should also mean you can access better rates than before.
If you’re worried about rising interest rates and you’re on a variable rate it could make sense to switch to a fixed rate. This can give peace of mind that your monthly repayments won’t keep going up even when the Bank Rate rises.
If you are currently on a fixed-rate deal, you may be able to save by switching to another fixed rate, depending on what rate you’re paying now. But don’t rush into any decision before checking if you’ll face early repayment fees on your current deal.
If you’re seriously concerned about your mortgage costs speak to your lender as soon as possible. It should help you try to find a way to make your repayments manageable – either through restructuring the debt (increasing the term to bring down monthly repayments for example) or with a short-term payment holiday, if appropriate.
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