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Could you afford your mortgage if rates rise?

If the UK’s interest rates rise, your mortgage costs are likely to rise too, meaning you may need to reassess your finances urgently or at least prepare for that event.

The Bank of England defines the ‘bank rate’, the charge that banks must pay in order to lend money to customers. If the Bank of England lowers the interest rate, then your mortgage rate is likely to also come down.

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There are some steps you can take to prepare for a mortgage rate rise, and also some signs of rates rising to watch out for.

About mortgage rates and repayments

The mortgage interest rate determines how much your monthly repayments will cost. The higher your interest rate, the higher your mortgage repayments.

However, your interest rate can change based on a few factors, and therefore you could end up paying more on your repayments, or if you’re lucky, less (read more below under ‘What affects mortgage rates?’).

You can also reduce the amount you owe by ‘overpaying’ on your monthly mortgage repayments. If you repay more than what you owe, you don’t pay interest on that amount, up to a certain limit depending on your mortgage lender’s rules.

Doing so would reduce your mortgage interest debt and therefore would mean you owed less on your future repayments overall. This is because of the way mortgage interest works.

How mortgage interest works

Mortgage interest is usually calculated as the APR or Annual Percentage Rate. That means the interest is calculated as the yearly cost, rather than the overall cost. So on a long loan, such as a mortgage, the interest can really add up to the point where you are sometimes paying more in interest than you are on the property.

Mortgage interest is ‘compounded’, meaning the interest debt accumulates ‘more interest’ the longer you leave the full balance unpaid.

This is why if, for example, you have a 5% interest mortgage valued at £200,000, your total debt to repay will not add up to £210,000 (because the interest is annual, rather than for the whole loan). In fact it will be much higher and lenders insist on you repaying the debt over a long period so that the interest compounds to a much higher amount.

Even on a 15 year mortgage at 5% APR, using the £200,000 figure above, you would likely owe in total around £415,000. Each year the interest adds up, but it also factors in the previous year’s interest as well.

That is why it is so important to try to reduce your mortgage interest when possible.

Capital repayment vs interest only mortgages

There are two main ways of repaying your mortgage every month: capital or interest only.

Capital repayments are the most common method of mortgage repayments and simply requiring you to pay a portion of the interest debt on the mortgage and a portion of the mortgage combined.

An interest only mortgage simply asks that you pay the interest debt on the mortgage every month. You still have to repay the mortgage, but usually interest only lenders do not ask for this until the interest repayments have been completed.

Interest only repayment mortgages are, as a result, far more risky than a capital repayment option. If you only repay the interest, then your monthly repayments will be far smaller than if you were also paying of the mortgage.

You might have more money left over at the end of the month, but you will still owe a large lump sum of cash once the interest only repayment plan is complete.

Since the Mortgage Market Review (MMR) in 2014, most mortgage lenders have removed the interest only repayment option from their products. As a result, you are more likely to only have the capital repayment option available to you.

What affects mortgage rates?

Mortgage rates are mostly affected by three key factors:

  • The Bank of England base rate
  • The mortgage market
  • Discounts or fixed rate deals

Every mortgage provider has their own ‘Standard Variable Rate’ (SVR) which is guided mostly by the Bank of England base rate, and partly down to other competitive mortgage market factors.

Once your fixed rate or discounted mortgage deal ends (which you are likely to be on for the first two or five years of your mortgage), then your lender’s SVR will kick in.

The SVR rises or falls according to the Bank of England’s changes to the base rate, but it may also change due to conditions in the mortgage market. However, the SVR is almost always higher than what you will be paying on your fixed rate or discounted rate.

The Bank of England base rate of interest

The biggest factor in potentially causing your mortgage interest rates to rise is the Bank of England. The Bank of England decides what to set the base rate of interest for lenders.

Generally speaking, when the UK’s economy is in good shape, interest rates tend to rise as people’s wages move in line to afford the more expensive mortgages.

When the economy is going through tougher times, such as coming out of a recession, the Bank of England is likely to lower the interest rate to encourage banks to lend money.

The interest rate also impacts savings accounts, so when the Bank of England lowers the base rate, you will also get less back on your savings interest.

It can be hard to predict when mortgage rates might rise, but they are very closely linked to what the Bank of England decides. It’s a good idea to keep up to date with what the Bank of England is discussing in the news so that you can prepare if rates do rise.

Mortgages and affordability criteria

When applying for a mortgage these days, you will be subjected to a strict affordability check, which factors in your finances in the event of possible changes to the Bank of England base rate.

Your regular subscription payments, lifestyle spending habits and credit card debts are also scrutinised to ensure that you will still have enough money left over to make your monthly mortgage repayments.

If you already have a mortgage this is something you should do for yourself regularly. Ask yourself if you could still afford your monthly mortgage repayments if rates went up. And look at any lifestyle spending habits that could be curbed or minimised.

What happens if you can’t make a monthly repayment

Your mortgage lender is required to attempt to make a reasonable arrangement with you so that you can continue repaying your mortgage.

Usually you can arrange to pay back some of the money – which is better than paying nothing. Obviously, you’re likely to owe more in the long run, but if it’s just a temporary measure to save your home from being repossessed it’s worth doing.

Your lender may also agree to extending your mortgage term to reduce the amount you owe each month.

If you can’t keep up with repayments due to a sudden change in your circumstances such as losing your job or becoming ill, you might be covered for this. Check if you took out mortgage protection insurance when you got your mortgage. It should be able to cover some of your mortgage payments.

Another option, but it could take a month or two, is to remortgage. Moving to a new mortgage could mean a discounted or cheaper fixed rate deal. You should always compare the remortgage market a few months before your current fixed rate or discounted rate deal comes to an end.

Could your home be repossessed?

Yes, your home is at risk of being repossessed if you fail to keep up with your monthly mortgage repayments.

That being said, mortgage lenders would prefer you continue paying your mortgage, so they are likely to be fairly reasonable if you bring your issue up with them.

Read more…

Compare fixed rate mortgages

Look at mortgages where your mortgage rate will remain at fixed rate for a set period of years.

Compare mortgages