As the Bank of England raised interest rates by 0.25 percentage points to 5.25 per cent on Thursday, many wondered how much harder household budgets would be hit.
The UK's mortgage market is more complex and fluid than, for example, that of the US. The vast majority of mortgages in the UK are fixed for either two or five years, while in the US, rates can be the same for 30 years.
It means UK households get to shop around for the best deals with a certain regularity. It also means that budgets can be quickly stretched when the Bank of England pushes interest rates higher over a short period.
Those on tracker mortgages – which move according to the Bank of England's base rate – will from Thursday be paying an average of £23.71 more per month, or almost £285 per year, according to figures from trade association UK Finance.
For homeowners on standard variable rate mortgages, the average payment could increase by £15.14 per month or nearly £182 per year.
Lenders of SVRs can, and usually do, follow base rate movements, although some will offer discounts.
The Bank of England's interest rate rise on Thursday was the 14th in the current cycle, which started in December 2021. Back then, interest rates were 0.25 per cent. Today, they stand at 5.25 per cent.
Crunch all these numbers and it means that average monthly payments will have increased by £488.50 for those on tracker deals and, assuming base rate rises have been fully passed on, £311.90 for SVRs.
That means an average annual increase of £5,862 for homeowners on tracker mortgages and £3,742.80 for SVR customers.
But all this will have passed by the majority of mortgage holders who are on fixed-rate deals.
Nearly eight in 20 mortgage holders in the UK are on two or five-year fixed-rate mortgages, which have risen substantially in popularity over the past 20 years.
Back at the start of December 2021, the average two-year fixed-rate mortgage was 2.34 per cent.
For example, if you had taken out a two-year fixed-rate mortgage in March 2022, you would probably have secured a deal at 2.65 per cent. When that deal expires in a little more than six months, a deal to replace it could have rates in excess of 5 per cent, meaning a serious and overnight extra hit to your household budget.
About 800,000 fixed-rate deals are ending in the second half of 2023 and 1.6 million deals are due to end in 2024, according to UK Finance.
“Those who have already fixed on to a new mortgage rate in the last few months will be facing significantly higher monthly payments, while many landlords have already passed on higher debt servicing costs to their tenants, making the private rented sector increasingly unaffordable to renters on low and middle incomes,” said Richard Lane, director of external affairs at StepChange Debt Charity.
But there is a geographical split across the UK as well. In southern England, house prices, and therefore mortgages, have been higher and therefore a percentage increase in rates has more of a monthly impact on bills.
“Higher mortgage rates hit harder in higher value markets in southern England, where a larger deposit and income are required to buy with a mortgage,” said Richard Donnell, executive director of research at property website Zoopla.
“In contrast, in the north of England and Scotland, house prices are still rising as the impact of higher mortgage rates is less pronounced.”
Nonetheless, a big increase in default and arrears is not expected in the mortgage market. UK Finance forecasts that the number of households that fall into arrears this year will not exceed 1 per cent of outstanding mortgages.
Means testing
Some of this is down to the mortgage affordability testing that was brought in after the 2008 financial crisis.
Banks and building societies lend money based on a formula that assumes the borrower can withstand interest rates up to 7 per cent higher. This means that while many struck low-rate deals two to five years ago, they were means tested at much higher rates.
As such, assuming the borrower's circumstances and income have not radically changed over the period of the fixed-rate mortgage, coming off will be painful but not wipe-out disastrous.
According to MoneyFacts, the average two-year fixed-rate homeowner mortgage rate on the market is currently 6.85 per cent, which is unchanged from Wednesday.
The average five-year fixed mortgage rate is at 6.36 per cent, down from 6.37 per cent on Wednesday.
Also, despite the predicted 0.25 per cent rise on Thursday, some major lenders, including NatWest, Halifax and Virgin Money announced rate cuts on some of their products days before the Bank of England's announcement.
Virgin Money said it was slashing the costs on some of the deals it offers mortgage brokers by up to 0.41 per cent.
Meanwhile, Halifax said on Wednesday that it was cutting the rate on its five-year fixed-rate remortgage products by 0.18 percentage points.
“Lenders have already priced this increase [by the Bank of England] into their fixed rates so we don't expect pricing to rise,” said Mark Harris, chief executive of mortgage broker SPF Private Clients.
“However, while other lenders may reduce their fixed rates, long gone are the days of rock-bottom pricing.
“Borrowers due to come off cheap fixes face a real payment shock, so it is important to plan ahead as much as possible and act now.”
The government also has a few measures in place aimed at preventing some of the worst-case scenarios that could potentially hit homeowners.
Mortgage lenders that represent 90 per cent of the market have signed up to the new mortgage charter.
Under the charter, lenders are obliged to offer those borrowers coming to the end of a fixed-rate deal the opportunity to lock in a new deal with the option for a better like-for-like deal should rates change up to six months ahead.
The charter also means that a mortgage holder is guaranteed that no repossession will take place within a year of first missing a payment.
Saving winners
Of course, the flip side of interest rate rises is the potential benefit to savers.
According to MoneyFacts, savers can now find a one-year deal that will pay at 5.21 per cent in interest and an easy access savings rate at 2.81 per cent.
“It is imperative savers take time to review their existing accounts and not presume any base rate rise will be passed on to them, as this is never guaranteed,” said Rachel Springall, a finance expert at MoneyFacts
“Those savers who have their cash sitting in an easy access account for convenience may find their loyalty is not being repaid.”
Even though savings rates have slowly been improving, it is estimated that £250 billion sits in deposit accounts and earns no interest.
Earlier this week, the Financial Conduct Authority set out a 14-point plan to make sure that banks and building societies are passing on interest rate rises to savers, something the institutions have been accused of not doing in the past.
The FCA also said that firms offering the lowest savings rates will have justify those rates and explain how they offer by the end of August.
The agency has the power to take action against those that cannot show how their savings rates are fair and said it would do so by the end of the year.
“While some banks have been quick to pass on higher rates to mortgage holders, they've dragged their heels on handing savers better deals,” said Jenny Ross, editor of Which? Money.
“Banks mustn't treat mortgage holders and savers differently by raising rates at different times.
“The regulator must continue to hold banks' feet to the fire – with tough action for those that continue to fall short.”
