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How to cope with an interest rate rise

Posted on 2018-10-24

The Bank of England decided last month to raise interest rates – from 0.5% to 0.75% - in what constitutes only the second increase in the last decade.

In a move that is expected to signal the end of record low rates, the Bank’s nine-strong Monetary Policy Committee (MPC) were encouraged to act by increased consumer spending, strong employment levels and the prospects of an improving economy. These factors offset concerns about Brexit and rising inflation.

While Mark Carney, the Governor of the Bank of England, has warned of further rate rises, these are likely to be ‘gradual’ and ‘limited’. Financial markets expect two further interest rate rises, of 0.25% each time, by 2020.

The chances of interest rates reaching 5% or above – as was commonplace before the global financial crisis hit in 2008 – are thought to be highly unlikely, but further small interest rate rises are expected across the next two years.

In a recent inflation report, the Bank of England said that the natural interest rate for the UK economy is between 2% and 3% - which suggests that borrowers don’t need to be too worried about any drastic increases in the coming years.

That said, the recent increase will have an impact on those with tracker or variable rate buy-to-let mortgages, with higher repayments for these borrowers. Further rate rises will also lead to extra costs, albeit by fairly small and tolerable amounts.

How much will the rate rise cost the average borrower?

The UK has around 9.1 million mortgage holders, with over 3.5 million of these on tracker or variable rate mortgages. The average standard variable rate mortgage is currently 4.72%, which means that someone with a £150,000 variable mortgage will see their annual mortgage costs rise by £224 (or just over £18 a month) as a result of the MPC’s decision.

Meanwhile, the average outstanding balance for someone on a variable rate mortgage is £112,000, which means that somebody with 20 years left on this mortgage would witness their monthly bills go up by about £14 a month.

Those on fixed-rate mortgages, of course, will be unaffected by the rise – although those coming to the end of their term could be hit by higher costs when they come to renew or change their mortgage.

How does the interest rate rise affect landlords?

Landlords with a mortgage have been encouraged to act now following the recent interest rate rise, completing new property purchases (and locking in more favourable terms) before borrowing costs rise too high. 

Landlords with a buy-to-let mortgage on a variable or standard variable rate will be most directly affected by the recent interest rate rise – and any further interest rate rises – but recent research has suggested that more landlords are on fixed-rate deals than previously thought.

Findings from letting agent Upad suggested that half of all landlords (50%) are currently on a fixed rate mortgage deal, which means their monthly repayments will stay the same each month regardless of what is happening with the base rate.

As a landlord, you may want to consider remortgaging to a fixed-rate deal ahead of the anticipated interest rate rises in 2019 and 2020, giving you peace of mind and reassurance that your monthly repayments will be consistent.

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At the same time, there is no cast-iron guarantee that interest rates will rise again, and you may not want to lock yourself in to a fixed-rate deal of two to five years – or longer. What’s more, the increase in costs for those on variable rate mortgages is fairly minimal and you might feel you can shoulder these comfortably.

Others, though, have suggested that buy-to-let landlords could feel the strain thanks to the rate rise – which comes on top of further changes in recent years which have stretched their finances.

Landlords are now faced with increased stamp duty on second homes, as well as changes to mortgage interest tax relief and tougher lending criteria. The upcoming ban on letting agent fees could also hit landlords in the pocket, in turn forcing them to increase rents or exit the market altogether.

In most cases, though, the rise in mortgage costs will be modest, which should enable most landlords to cope if they are letting in a good location with decent rental yields on offer.

What mortgages are best for landlords?

Most landlords will opt for a fixed-rate or tracker loan. The advantage of a fixed-rate buy-to-let mortgage is the stability and certainty it provides – in other words, you know exactly what you’ll be paying each month, which allows you to budget accordingly and decide whether expanding your portfolio is a realistic goal. 

Tracker or variable rate mortgages, though, are often cheaper, so could be your best option if you are happy to accept fluctuations in your mortgage costs depending on what happens with the base rate.

Average mortgage repayments on a buy-to-let home tend to be pretty cheap – standing at £360 in December 2017, according to MoneySuperMarket. That’s largely because most buy-to-let loans are interest only rather than repayment. This means you pay only the interest each month before clearing the capital debt when the property is sold. There are upsides and downsides to interest-only mortgages, but for this type of purchase it’s typically seen as the best option.

Given the fairly modest increase, you should be able to cope with the recent rise in interest rates – and future interest rate rises should be similarly gradual. If you want to avoid changeable costs, though, a fixed-rate deal would work best for you.

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