Posted on 2 November 2017 by
The Bank of England’s Monetary Policy Committee (MPC) today voted 7-2 to raise interest rates for the first time in more than a decade.
The last increase in Bank Rate was in July 2007, just before global credit markets started to freeze up ahead of the full-blown global financial crisis – so what impact will the rate hike have on the UK housing and mortgage market? We asked our expert Ray Boulger for his analysis:
The decision to increase the rate was widely expected and as such the cost of fixed rate mortgages has risen slightly over the last few weeks but remains close to all-time lows. Borrowers wanting to switch to a new fixed rate have had plenty of opportunity to lock into rock bottom rates over the last year, so there is unlikely to be a mad rush to fix now just because Bank Rate has increased by 0.25%. However, for those who haven’t yet switched the Bank Rate increase may just be the catalyst they need to act before rates rise further.
Gilt yields, and hence swap rates, increased by about 0.25% over the last 2 months in anticipation of in today’s Bank Rate increase. This has pushed up the cost of fixed rate funds to lenders and so the cost of fixed rate mortgages, from the majority of lenders, already reflects today’s rate rise.
Therefore the biggest impact on borrowers is likely to be a reduction in the maximum loan most lenders will offer. The Bank of England’s Financial Policy Committee (FPC) requires lenders in most cases to stress test borrowers’ affordability on the basis of a 3% increase in the revert to rate, which is normally the lender’s Standard Variable Rate (SVR). The main exception is for fixed rates of at least 5 years, where lenders are allowed to use a lower rate for the stress test, but very few lenders use this flexibility.
A problem with any rigid rule, such as the requirement to calculate affordability on this basis, is that with every Bank Rate change the FPC really needs to consider whether the margin should also be changed. However, as the FPC only meets quarterly there will be a time lag before any such consideration can be made. It may of course be that when the FPC next reviews the margin it decides, contrary to the view of nearly all lenders, that a 3% margin is still required. However, logic dictates that every time Bank Rate changes, up or down, The Bank should simultaneously consider whether the margin over the revert to rate lenders are required to use should be changed.
The key issue influencing the short-term trend in interest rates from here was always going to be how the market reacted to the MPC’s statement and this will also determine whether the cost of fixed rate mortgages increases further.
The statement was in fact quite dovish and so initial gilt market reaction was very positive, with the yield on 2 – 10 year gilts falling by 8 basis points. This will feed through to swap rates and hence lenders’ cost of funds should fall. Therefore, despite the Bank Rate increase there is little reason for the cost of fixed rate mortgages to rise further, except perhaps for any lender which hasn’t recently increased rates!
A key part of the MPC’s statement is the comment that:
“Monetary policy… can, however, support the economy during the (Brexit) adjustment process. The MPC’s remit specifies that, in such exceptional circumstances, the Committee must balance any trade-off between the speed at which it intends to return inflation sustainably to the target and the support that monetary policy provides to jobs and activity.”
The MPC also highlighted that:
“There remain considerable risks to the outlook.”
These comments reinforce a view that pace of rate increases will be relatively slow and the greater uncertainty over the outcome of the Brexit negotiations the more cautious the MPC is likely to be on further rate rises.
I expect most lenders will increase their Standard Variable Rate (SVR) by 0.25% but some of those with SVRs in excess of 5% may decide their margins are high enough and decide not to pass on the hike. Most borrowers on either an SVR, a discounted SVR or a tracker, will see their rate increase from the beginning of December, regardless of when their lender actually makes the announcement.
With one exception the top 6 lenders’ SVRs (in Barclays’ case its revert to tracker rate) are in the region of 3.75%, but Santander is out of line with its peers, with its SVR being 0.75% higher at 4.49%. This may explain in part why, despite strong gross lending, it struggles to boost net lending and therefore it will be interesting to see if Santander chooses to narrow the gap with the other major High Street lenders by leaving its SVR unchanged.
There are still plenty of 5 year fixed rate mortgages on offer under 2%, with the cheapest remortgage for loans up to 60% LTV being from Tesco Bank, with a rate of 1.73%, a £995 fee, a free valuation and free legal fees. For LTVs up to 50% and a mortgage over £500,000 Virgin Money offers a cheaper deal with a rate of 1.69%, a fee of £1,995 and also a free valuation and free legal fees.
Even with a loan to value at 80% the rate doesn’t increase much, with the cheapest 5 year fix at this LTV being offered at 1.85%, with a fee of £1,149 and a free valuation and free legal fees.
There is already a big gap between even the lowest SVRs (which are likely to increase to around 4%) and fixed rates, even for those without much equity, and so there is already a big incentive to switch to a fixed rate. However, with most SVRs likely to increase by 0.25%, and no reason to expect any further increase in the cost of fixed rates, the gap between the two rates will widen by around 0.25%, meaning the savings from switching to a fixed rate will be even greater!
Most borrowers who are coming to the end of their current deal, or paying SVR, will therefore be able to avoid being hit by the Bank Rate increase, simply by switching to a new cheaper deal, either with a product transfer or by remortgaging.
Even someone who is thinking of moving, or for any other reason doesn’t want to be locked into early repayment charges (ERCs), will in most cases be able to find a much cheaper deal by switching.
The blog postings on this site solely reflect the personal views of the authors and do not necessarily represent the views, positions, strategies or opinions of John Charcol. All comments are made in good faith, and neither Charcol Limited nor Ray Boulger will accept liability for them.