If you’ve watched even a snippet of news over the last few months, you’ll be well aware that interest rates are rising, inflation is exceeding forecasts, and everything is becoming more expensive.
Here we’ll explain what that all means, how it impacts your mortgage, and the potential solutions to keep your outgoings under control!
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The link between inflation and mortgages
Inflation is a term batted around a lot, but essentially it means that prices for goods and services have increased.
Many reports refer to the Consumer price index (CPI) and/or the Retail Prices Index (RPI).
These measures look at average costs for everyday items, such as a basket of typical products you might buy in a supermarket, and calculate how much prices have risen.
For example, if the CPI has a 2% rate, prices are 2% higher than a year ago.
The RPI is the important metric here because that’s the figure that includes mortgage repayment costs and housing prices.
Why do Consumer Prices matter to mortgage costs?
The Bank of England is the central bank in the UK, and decisions about base rates (we’ll come onto that shortly) are made by a group called the Monetary Policy Committee.
They look at CPI and RPI and decide whether it’s necessary to increase – or decrease – base rates.
Base rates are used throughout mortgages because a lender will use that as the basis for the interest rates they charge you.
Every lender has a Standard Variable Rate (SVR), which takes the base rate, and adds percentage points on top – SVR is the default interest you pay on your mortgage if you’re not on a fixed-term deal or within another agreement.
So, if the base rate is 0.1% and a lender charges (theoretically) 3% above the base rate, you pay 3.1%. If that base rate climbs to 2%, your payments boost to 5%.
The rate right now is 2.25%, which increased up from 0.1% back in December 2021, and then to 1.75% in September 2022.
What can I do to manage the rising cost of my mortgage?
The first thing to do, particularly if you’ve noticed your mortgage payments rising, is to review what sort of deal you’re on.
You need to understand the terms of your mortgage agreement, the basis of your interest rate calculations, and whether you’re locked into a period before deciding on the best way forward.
Interest rates can be calculated in multiple ways, so your loan could be:
- Fixed-rate – usually for a two, three or five year period. You could be on a fixed term for up to ten years, although that’s less likely.
- Standard Variable Rate – this is the default rate we mentioned above and follows the Bank of England base rate, plus the lender’s interest charge.
- Discounted interest – these mortgages work like the SVR but charge you interest based on a specific amount less than the lender’s SVR. For example, one bank might offer discounted interest on 2% beneath SVR and another 1%, so the exact rate will vary.
- Tracker mortgages move in line with the base rate like an SVR, although you pay interest at a lower rate, usually locked in for two to five years.
If you were previously on a fixed rate, but the term has ended, your lender will automatically swap you onto their SVR. That is normally the highest cost, so you might have a great opportunity to refinance (with another lender or the same mortgage provider).
However, fixed terms are locked in, and you need to check your documents for early repayment penalties.
Applying to settle a mortgage early might be very costly indeed (some early settlement fees are extremely steep), in which case you’re better off speaking to your lender about the options they can offer.
Fixed-rate vs variable mortgages in an inflationary economy
Because interest rates have risen across the board, you’ll inevitably find fixed rate deals quoted at a higher interest rate than a couple of years ago – but that doesn’t mean you can’t reduce your monthly outgoings.
If you’re in a position to remortgage with another provider and want the assurance of a stable monthly payment, a fixed deal can be attractive.
You should always check the tracker deals available, too, because although it’s a bit of a gamble, you will often find that the rates offered are lower than the fixed rate.
Other options to reduce your monthly payments include:
- Extending the term – most mortgages run for 25 years, but you might have considerably less time to run if you’ve been in your home for a while. Extending the term (say, adding another ten years to the final payment date) does mean you’ll pay more altogether but will mitigate the monthly cost.
- Looking at interest-only deals – these are generally more suitable for rental properties. Still, some lenders will consider an interest-only agreement, sometimes for a limited period, to give you a little breathing room.
Remember that your mortgage is probably the highest amount you’ll ever borrow, and it’s essential never to go into an agreement without conducting thorough research.
Do your sums, research competing deals, or use an independent broker to ensure you’re confident that whichever decisions you make are suitable for you.