Millions of mortgage borrowers will continue to face a financial shock in the coming years as they continue to forego cheap fixed interest rates.
It is estimated that 1.6 million households will need to take out a new mortgage this year, many of whom will receive interest rates below 2 percent.
This pain is expected to continue into 2025, with mortgage rates unlikely to fall dramatically from current levels.
Yesterday, the Office for Budget Responsibility predicted that average mortgage rates will peak at 4.2 percent in 2027.
Less painful? The average mortgage interest rate (taking into account all mortgage households) is expected to peak at 4.2 percent in 2027. This is 0.8 basis points lower than the OBR’s previous forecast
This is an increase from a low of 2 percent at the end of 2021 and above the average mortgage rate in the 2010s of around 3 percent.
The OBR average rate includes all fixed and variable rates that households currently pay.
This also applies to those who use a very low fixed interest rate. Therefore, the rates are lower than the market average, which many will be more familiar with.
The market average rate, as reported by Moneyfacts, takes into account every fixed rate deal currently available to those buying or remortgaging.
This includes the very cheapest rates, but also the most expensive rates – reserved for those with niche circumstances or poor credit history.
Currently, the average two-year fixed-rate mortgage rate is 5.76 percent and the average five-year fixed-rate mortgage rate is 5.34 percent, according to Moneyfacts.
While average rates are useful for tracking the market as a whole, in reality many people will be able to do much better than the average.
The cheapest five-year interest rate for those with at least 40 percent equity or a deposit is currently just above 4 percent.
Even the cheapest five-year fixed interest rates for people with a 10 percent deposit or equity are around 4.6 percent.
Mark Harris, CEO of mortgage broker SPF Private Clients, said: ‘Average mortgage rates are of limited use as they can mask a significant range of prices, from the cheapest rates for people with significant equity to much more expensive deals for people considered to have a larger risk because they don’t have much down payment.
‘That said, borrowers have to get used to higher interest rates and paying more for their mortgage.
‘Many will face a significant payment shock if they move on from cheap fixed rates, and it’s important to plan ahead and use a broker who covers the whole market to ensure they don’t pay more than necessary .’
What now with the mortgage interest?
The good news is that the OBR’s latest mortgage rate forecast was 0.8 percentage points lower than what the OBR forecast earlier in November.
The OBR said this was due to a decline in market expectations for the Bank of England’s base rate, which currently stands at 5.25 percent.
The base rate is important because it determines the interest paid on the reserves that commercial banks hold with the Bank of England.
By setting the base interest rate, the Bank of England can therefore control the short-term market interest rate.
The OBR says the market now expects the base rate to fall this year from the current peak of 5.25 per cent to 4.2 per cent by the end of 2024.
However, looking further ahead, markets are currently only pricing in a drop in the base rate to 3.8 percent by the end of 2025 and ultimately to 3.5 percent in 2027.
Is the worst behind us? Mortgage rates have started to rise again after falling back from the highs they reached in the summer
For mortgage holders, these market expectations are reflected in the Sonia swap rate.
Mortgage lenders enter into these agreements to protect themselves against the interest rate risk associated with providing fixed-rate mortgages.
Put more simply, swap rates show what lenders think the future holds in terms of interest rates, and this determines their pricing.
As of today, the five-year swaps were 3.88 percent and the two-year swaps were 4.49 percent – both below the current base rate.
To put that in context, from a historical perspective, it is very rare for the lowest priced fixed mortgage rate to fall below the swap rate, although this did happen for a very short period in January.
If and when base rates start to fall, it could trigger good signals to the sector, meaning swaps could fall further.
But this doesn’t necessarily mean there will be significant rate cuts on fixed rate products right away, as lower rates are already priced in as there is already an expectation that rates will fall.
Economist Andrew Wishart says many of the cheapest mortgage rates are very close to the swap rate, which he thinks will not fall further until the Bank of England actually starts cutting.
Last week, the Bank of England’s chief economist Huw Pill, speaking at Cardiff University Business School, suggested that a cut in the base rate is still some way off.
He warned: ‘We must be careful not to be lulled into a false sense of security about inflation.
“While I recognize that we are now seeing the first signs of a downward shift in the persistent component of inflation dynamics, those signs so far remain tentative. In my opinion, we still have a long way to go before such evidence becomes definitive.
“Even if we become more confident that the persistent component of inflation is declining, that does not mean that the MPC no longer needs to maintain its restrictive stance.
‘The time for a reduction in bank interest rates is still far away.
‘I need to see more convincing evidence that the underlying, persistent component of CPI inflation is being reduced to rates consistent with a sustained and sustainable achievement of the 2 percent inflation target before voting for a cut in the bank rate.
“It is that view that led me to vote to leave the bank rate unchanged in February.”
That said, economists at Capital Economics noted that the OBR had made a major downward revision to its CPI inflation forecast.
The OBR now expects CPI inflation to fall from 4 percent in January to below the 2 percent target in the second half of the year, reaching a low of 1.1 percent in early 2025 and remaining below 2 percent until 2027 . .
In its November autumn statement, the OBR did not expect CPI inflation to fall below 2 percent until 2025.
This makes the Bank of England’s February forecast that inflation will remain above the 2 percent target for most of the next three years look like an outlier.
It may not be long before the Bank starts to worry about inflation being too low. This could theoretically encourage its members to cut interest rates further and faster than markets have currently priced in.
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