Mortgage rates are falling but borrowers aren’t out of the woods yet

The top five-year fixed-rate mortgages fell below 4 percent this week – the latest chapter in the UK’s upside-down interest rate story.

The arrival of a 3.99 per cent five-year fix from HSBC, quickly undermined by a 3.95 per cent deal from Virgin Money, comes despite the Bank of England raising key rates by 0.5 per cent last week.

The base rate has now accelerated from 0.1 percent to 4 percent in just over a year and is widely expected to rise further to a peak of 4.5 percent.

So, how did we end up in a scenario where banks and building societies cut mortgage rates, in the opposite direction of the Bank of England’s moves?

There are a number of different elements to the game.

Part of the puzzle is the spike in mortgage rates following Liz Truss and Kwasi Kwarteng’s ill-fated mini-Budget.

The turmoil that followed involved a mini-financial crisis triggered by a combination of their clumsy debt-funded tax cuts and the pension industry playing with investment fire.

As bond markets panicked, banks and building societies ducked for cover, pulling large chunks of their fixed-rate mortgage offerings and raising rates on what was left.

The average five-year fixed interest rate shot up to 6.5 percent at the end of October, well ahead of the Bank of England’s rate decisions.

Part of the decline we’ve seen in mortgage rates since then represents a recalibration after that peak.

Another factor that comes into play is that banks and building societies are still keen to lend people money – and now that interest rates on buying property have fallen, we’ve probably moved back into a position where they’re more inclined to are to borrow than people to borrow.

Bank balance sheets are in good shape, relatively loose on rising defaults and bad debts, and looking to take advantage of higher mortgage rates. The return of lenders to the market has led to a bit of a price war.

Finally, there is the expectation that we are close to the interest rate peak and that the Bank of England will remain stable once inflation falls – and may even have to lower soon.

On a side note, former MPC member Danny Blanchflower told Bloomberg this week that he foresees a housing market crash that will lead to rate cuts sooner than the bank thinks.

Put all these things together and you have a mortgage market that looks a lot less scary and a lot healthier than it was a few months ago.

There’s a question about how much further mortgage rates fall: Will we hit a five-year fix of 3.5 percent?

But there’s also a general air of calm and you get the sense that mortgage lenders feel we’ve somehow gotten away with the sharp rise in interest rates (something I suspect the Bank of England and Treasury also think).

Look at the stock market and you get the impression that investors feel the same way. The FTSE 100 has finally hit a new all-time high and major global markets have just had one of their best starts in a year.

But. (And there’s always a but.)

I can’t help but feel that maybe we’re being overly optimistic and maybe prices have moved up so fast that we haven’t quite clocked the full impact yet.

The Bank of England said in its Monetary Policy Report: ‘It is estimated that 1.7 million mortgages will reach maturity in 2023. For the average mortgagor within that group, annual interest payments will increase by just under £3,000 if their mortgage rates rise by 350 basis points – the increase implied by quoted mortgage rates.’

That’s a lot of people and a £3,000 drain on their annual income is huge.

Some are in a lot more pain, I’ve spoken to people staring at double this, with £500 a month mortgage payments.

And it’s not just the hapless cohort of borrowers in late 2022 and 2023 that’s in trouble. The prospect of their mortgage payments rising is leading many people with fixed-rate mortgages with a few years left to reassess their finances.

The overall impact will be a major drop in the ability of much of the population to spend and save.

It’s good news that mortgage rates are falling, but I don’t think we’re out of the woods yet.