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If you took out a fixed-term mortgage before December of last year, you may be breathing a little easier than friends or family who have a variable interest rate or who recently had to take out a new mortgage.
In December, a two-year mortgage had an average interest rate of 2.34 percent, but that has now risen to 4.81 percent, according to Money Facts.
And interest rates are expected to continue rising as lenders and the Bank of England grapple with their response to Chancellor Kwasi Kwarteng’s ‘mini-budget’ on Friday.
Mortgage rate hikes come amid the cost of living crisis as food and fuel costs are pushed up and household finances come under pressure
That led to tax cuts across the board, rocking markets and skyrocketing government borrowing costs.
In addition, the Bank of England raised its base rate further by 0.5 percent last week, pushing it to 2.25 percent as lenders moved to include the hike in their new fixed-rate mortgages.
This is bad news for mortgage holders. As the cost of borrowing rises, it becomes more expensive for lenders to manage the risk they take when offering mortgages, and as a result they increase the costs for borrowers.
Borrowers with tracker mortgages that track the base rate will see their monthly fees rise again, while those with standard variable rates are also likely to see costs rise as lenders pass the increase.
Most expect interest rates to continue rising next year, with some forecasting a key rate hike to 5.8 percent.
While stress tests for lenders mean that borrowers who have taken out mortgages since 2014 should be able to withstand interest rates of up to 7 percent, these tests don’t take into account broader economic pressures, such as rising inflation, that affect households’ overall budget.
In August inflation reached 9.9 percent, far from the Bank of England’s target of 2 percent, driven by energy and food prices.
Floating rate borrowers are more exposed to increases than those with fixed rate deals, as the latter are only affected if they refinance
According to data from the Bank of England and the Financial Conduct Authority, payment 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 payment arrears reached £2. 09 billion.
Homeowners should continue to pay their mortgage payments at current levels if possible. However, the unprecedented nature of the current interest rate hikes and inflation means that some may no longer be able to do so.
Talk to your mortgage lender in time
“If you’re in arrears or getting into trouble, it’s best to talk to your lender,” said Nick Mendes, mortgage technical manager at John Charcol.
‘Households [budget] the pressure is rising like never before and the mortgage interest rate is also rising. It’s a double whammy.’
Advice to clients from the Financial Conduct Authority is that if a client is in arrears (meaning they have missed mortgage payments) or is in danger of default, they should contact their mortgage lender as soon as possible.
Together with them, they go through the client’s budget to get the best possible idea of the options available.
It’s also worth checking your insurance policies as some include mortgage coverage under certain circumstances.
There are several ways to reduce monthly payments in the short term – although most will mean that the mortgage will cost more in the long run.
Switch to interest-only mortgage
The first option to reduce your costs may be to temporarily switch from an interest-only mortgage to an interest-only option.
This effectively pauses their outstanding mortgage at the current level. The borrower stops paying off the loan balance and instead only pays the interest that accrues each month.
“Interest alone will lower the monthly payment, which could give valuable breathing room,” explains David Hollingworth of mortgage broker L&C.
However, this move should be considered temporary. The borrower will have less time to repay the mortgage balance once he switches back, and more interest will have to be paid each month to make up for the time lost.
The greater danger is if the mortgage is never repaid. This can become a major problem if the end of the term is reached without any way to repay the mortgage balance.
Often, in this situation, borrowers are forced to sell their homes in order to repay the bank.
Ask for a payment holiday or a discount on the mortgage
The second option is to ask your lender for a mortgage payment vacation, also known as a payment deferral. This allows a homeowner to temporarily stop or reduce their monthly mortgage payments.
Pay vacations were used by some borrowers who were struggling financially during the pandemic, as banks had to offer them to any customer seeking one.
In the first three months after the scheme’s launch, one in six mortgages was subject to deferred payment, with the typical deferred payment totaling £755 per month.
Banks are no longer required to offer payment holidays to borrowers, but those who are struggling can talk to them and request one. Lenders will likely want borrowers to maintain a certain level of payment each month, rather than stopping altogether.
Research by the Bank of England shows that mortgage borrowers with deferred payments were less likely to cut spending elsewhere during the pandemic.
Warning: Lowering your short-term mortgage payments usually increases the total amount owed
Again, it’s important to remember that payments will be more expensive when the vacation ends, to repay the mortgage at the end of the term. The extra accrued interest is added to the outstanding mortgage.
Mendes said, “You have to factor in the higher cost to pay in total. You can get a deferment of payment or reduce your monthly repayment, but in six months your repayment will be higher’
Extend the term of your mortgage
A third option is to extend the term of your mortgage in order to spread the repayments over a longer period. For example, you can extend a 25-year mortgage for another five years to make it a 30-year term.
For those with a fixed deal, this usually has to be done at the time of transfer. Banks don’t usually offer mortgages with maturities over 40 years, and they often won’t renew your mortgage if it means you’ll still be paying it until you retire or after a certain age.
Again, this will help reduce the amount of each monthly payment, by restructuring the mortgage over a longer term, but will incur a higher cost in terms of interest payments.
However, unlike an interest-only option, this does mean that the mortgage will eventually be repaid, even if the term is never reduced to the original term.
Support Mortgage Interest Scheme
In addition to direct solutions with your lender, the government runs the Mortgage Interest Deduction Support scheme that lends money to low-income people 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 portion of a mortgage. They cannot be used to pay the balance.
It is only available to homeowners who already receive government benefits, such as income support, means-tested jobseeker’s benefit, or retirement credit.
The money received through the scheme is a loan — not a distribution — meaning it’s added to your home’s outstanding balance.
There are also services such as: Citizen advice and Money Helper who provide free and independent advice on financing issues and can possibly discuss the options with you.
For those who think they will struggle with mortgage payments in the long run, another option to consider selling the home is perhaps moving to a smaller home with cheaper mortgage payments.
This is more realistic for people with significant equity in their home, which they could use as security for another property or even to buy one.
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