How to weather an interest rate rise
First published on 03 of September 2015 • Updated 13 of March 2018
The news keeps hinting that a rise in interest rates is only a matter of time – it’s just that no-one’s sure exactly when it might happen. So it’s a good idea to review your own mortgage now, to make sure your home will be secure whichever way the wind blows.
Esme is kicking herself. Her £180,000 fixed-rate mortgage looked so good when she took it out, she didn’t consider its drawbacks. Because she spoke only to her provider rather than engaging a mortgage adviser, she didn’t fully appreciate that this mortgage came with a ‘collar’ to keep her locked in. Now, after two years of nice and low interest rates, she finds herself back on the lender’s standard variable rate (SVR) which is much higher – and the collar means she can’t switch for another three years without paying a hefty redemption penalty (many thousands of pounds). She’s livid. But that’s not even the worst of it.
The other day she heard that the Governor of the Bank of England is considering an interest rate rise. He isn’t yet saying when this will be, but Esme knows it’s bound to happen sooner or later, while she’s still locked into her SVR mortgage. Which means her already high repayments will probably rise even higher – and it seems there’s absolutely nothing she can do about it.
OR IS THERE?
With a billowing cape, a financial adviser swoops down. Actually she just found him on unbiased.co.uk, but the effect on her morale is much the same.
The adviser helps her do the sums again. Although switching to a lower interest fixed-rate mortgage will cost thousands of pounds in redemption fees, her monthly payments will then be a lot lower, so she’ll start to make that money back. Esme (who isn’t stupid) points out that it still won’t save her as much as the redemption penalty over a three-year period – she’d still be down by around a thousand pounds. So doesn’t it make more sense to stick with the SVR?
No, says the adviser. There are still two big reasons why switching is better. Firstly, the SVR will rise if base rate inflation goes up, so staying there is a risky strategy. But even more importantly, there are other savings to consider. If Esme is paying a lower rate of interest, that means more of each monthly payment is going towards repaying the capital sum of the loan. So she will be reducing the size of her mortgage at a faster rate. By the end of three years, even after the early repayment fees and arrangement fees and the cost of the advice itself, Esme would have saved herself several thousand pounds by switching from an SVR mortgage to a fixed-rate one.
How to save money on your mortgage
Everyone’s mortgage arrangements are different, so you might not achieve the same kind of savings as Esme – but it’s more likely than not in a majority of similar situations. At the very least, it’s always worth investigating to see if switching mortgages can save you money, even if you think the penalties won’t make it worthwhile. A financial adviser or a mortgage broker can crunch the numbers for you, and the answer can be very surprising.
At this point no-one knows when the base rate of interest will rise, or by how much. All we do know is that a rise is inevitable, sooner or later – so make sure you understand how any change could affect your situation, and that you know where to turn for advice.