By Fran Ivens For This Is Money
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If you took out a fixed-term mortgage before December last year, you may be breathing a little easier than friends or family who are on variable rates or have recently had to remortgage to a new deal.
In December a two-year fixed mortgage had an average interest rate of 2.34 per cent but that has now shot up to 4.81 per cent, according to Money Facts.
And rates are expected to keep rising as lenders and the Bank of England grapple with their response to Chancellor Kwasi Kwarteng’s ‘mini-Budget’ on Friday.
Mortgage rate increases come amid the cost of living crisis as food and fuel costs are being pushed up and putting pressure on household finances
That introduced tax cuts across the board, spooking markets and sending the cost of government borrowing soaring.
In addition the Bank of England further increased its base rate last week by 0.5 per cent, pushing it up to 2.25 per cent as lenders moved to incorporate the hike into their new fixed rate mortgages.
This is bad news for mortgage holders. As the cost of borrowing goes up it becomes more expensive for lenders to manage the risk they take on when offering mortgages, and as a result they increase the cost for borrowers.
Borrowers on tracker mortgages following the base rate will see another rise in their monthly costs, while those on standard variable rates are also likely to see costs rise as lenders pass on the hike.
Most expect rates to continue rising next year, with some forecasting a base rate increase to 5.8 per cent.
While lender stress tests mean borrowers who took out mortgages since 2014 should be able to withstand interest rates of up to 7 per cent, these tests do not take into account wider economic pressures such as rising inflation which impact households’ overall budgets.
In August inflation hit 9.9 per cent, far off the Bank of England’s target of 2 per cent, driven up by energy and food prices.
Borrowers on variable rates are more exposed to increases than those on fixed rate deals, as the latter will only be affected when they come to remortgage
Mortgage arrears reached a 12-year high of £2.05 billion at the end of the first quarter of 2022, the highest figure since June 2010 when arrears touched £2.09 billion, according to data from the Bank of England and the Financial Conduct Authority.
Homeowners should continue to make their mortgage payments at their current level if at all possible. However, the unprecedented nature of the current rate rises and inflation may mean some are no longer able to.
‘If you are in arrears or facing hardship then the best advice is to speak with your lender,’ says Nick Mendes, mortgage technical manager at John Charcol.
‘Household [budget] pressures are rising like never before and mortgage rates are increasing as well. It’s a double whammy.’
Advice to customers from the Financial Conduct Authority is that if a customer is in arrears (meaning they have missed mortgage payments) or at risk of arrears, they should speak to their mortgage provider as soon as possible.
They will run through the customers’ budget with them to get the best idea of what options are available.
It is also worth checking your insurance policies as some include mortgage coverage under certain circumstances.
There are several ways to reduce the monthly payments in the short term – though most will mean the mortgage ends up costing more in the long run.
The first option to reduce your costs could be switching from a repayment and interest mortgage to an interest-only option temporarily.
This effectively pauses their outstanding mortgage at its current level. The borrower will stop paying off the balance of the loan, and instead pay only the interest that accrues each month.
‘Interest only will reduce the monthly payment which could give some valuable breathing space,’ explains David Hollingworth of mortgage broker L&C.
However, this move should be treated as temporary. The borrower will be left with less time to repay the mortgage balance once they switch back, and more interest will have to be paid each month to make up for missed time.
The bigger danger is if the mortgage is never switched back to repayment. This could become a major problem if the end of the term is reached without any way of repaying the mortgage balance.
Often, borrowers in this situation are forced to sell their home to pay back the bank.
The second option is to ask your lender for a mortgage payment holiday, also known as a payment deferral. This allows a homeowner to temporarily stop or reduce their monthly mortgage payments.
Payment holidays were used by some borrowers that were struggling financially during the pandemic, as banks were required to offer them to any customer that sought one.
In the first three month after the scheme’s launch, one in six mortgages were subject to a payment deferral, with the typical suspended payment totalling £755 per month.
Banks are no longer required to offer payment holidays to borrowers, but those struggling can speak to them and request one. Lenders are likely to want borrowers to maintain some level of payment each month, rather than stopping altogether.
Research from the Bank of England shows that mortgage borrowers with payment deferrals during the pandemic were less likely to cut their spending elsewhere.
Warning: Reducing your mortgage payments in the short term will usually increase the overall amount owed
Again, it is important to remember that payments will be more expensive once the holiday ends, in order to pay back the mortgage by the end of the term. The extra interest accrued will be added to the outstanding mortgage.
Mendes said: ‘You have got to take into account the increased cost of paying overall. You can take a payment deferral or reduce your month repayment, but in six months’ time your repayment will have gone up’
A third option is extending the duration of your mortgage in order to spread the payments over a longer period of time. For example, you could extend a 25 year mortgage by an extra five years to make it a 30-year term.
For those on a fixed deal, this usually needs to be done at the point of remortgage. Banks don’t commonly offer mortgages of more than 40 years in length, and they often won’t extend your mortgage if it means you will still be paying it into retirement or past a certain age.
Again, this will help to reduce the amount of each monthly payment, by restructuring the mortgage over a longer term but will come at a bigger cost in terms of interest payments.
However, unlike an interest-only option, it does mean the mortgage will ultimately be repaid, even if the term is never reduced back down to the original timeframe.
In addition to direct solutions with your lender, the Government runs the Support for Mortgage Interest scheme which loans money to those on low incomes to help them meet their mortgage payments.
The scheme offers low-interest loans from the Department of Work and Pensions to help pay the interest element of a mortgage. They can’t be used to pay down the balance.
It is only available for homeowners already receiving Government benefit support such as income support, income-based Jobseeker’s Allowance, or pension credit.
The money received through the scheme is a loan – not a benefit – meaning it is added to the amount outstanding against your house.
There are also services such as Citizens Advice and Money Helper that provide free and independent advice with finance issues and may be able to discuss options with you.
For those who think they will struggle with mortgage payments in the long term, another option is to consider selling the home, perhaps moving to a smaller property with cheaper mortgage payments.
This is more realistic for those with substantial equity in their home, which they could use as a deposit for another property or even to buy one outright.
The cost-of-living crisis has put our finances into sharp focus. If you’re looking for inspiration to save money or audit your finances, the following checklist might help:
Check your savings rate: Many big banks continue to pay a pittance while challengers are raising rates. Here are the best savings deals from our independent tables.
Learn about DIY investing: Want to know how to invest but don’t know where to start? Here’s how to choose the best (and cheapest) stocks and shares Isa and the right DIY investing platform.
Haggle a better broadband, TV or phone deal: Many of us are guilty of overpaying once a contract expires with telecoms giants. Compare broadband, phone and TV packages to see if you can save money.
Compare insurance: When it comes to car, home and travel insurance, it is important to shop around, make sure you have the right level of cover and use a highly-rated company. See if you can find a cheaper deal with our comparison service powered by Compare the Market.
Mortgage rate: Whether you’re buying a new home, remortgaging to a new deal or buying an investment property, our partner L&C can help you find the best rates – and you’ll pay no fee for their advice.
Energy tips: Energy prices are soaring. Here’s what you need to know, whether you can still fix and energy-saving tips that work.
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