Updated 17 May 2019
A rise in interest rates is only a matter of time – it’s just that no-one’s sure exactly when. 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. Article by Nick Green.
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.
She knows interest rates have been at an all-time low for years, but that this probably won't last forever. An interest rate rise is bound to happen sooner or later, while Esme is 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?
Esme contacts a mortgage broker, who 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 mortgage broker. 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.
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 mortgage broker (or financial adviser) 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.
To prepare for your mortgage switch or application, it can be really helpful to use our Mortgage Checklist.
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