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Interest rates are expected to rise for the first time since 2018. Financial markets are forecasting that the Bank of England (BoE) will be forced to increase interest rates before the end of the year. Perhaps more startingly, markets are predicting that interest rates will increase to 1.00% by August next year. That is a relatively significant increase from the current base rate of 0.10%.
Still, you may wonder whether a 0.90% increase to interest rates is anything to truly write home about? Should the market’s predictions prove to be right (which they tend to be on balance), then investors are set to witness the largest increase in interest rates in over a decade and the highest base rate since 2009.
Why is an Increase in Mortgage Rates so Significant?
Fundamentally, interest rates are a phenomenally important and often misunderstood factor in property investment. Increases to the Bank of England’s base rate can feed directly through into house prices and the mortgage premiums investors can expect to pay each month.
Interest Rates and Variable Rate Mortgages
Nearly a third of the UK’s £1.6 trillion of mortgages are on variable rate deals or trackers. That means that the interest rates on these mortgages are calculated as a fixed rate above the Bank of England’s base rate. If the base rate increases by 0.90%, so too will the interest rate you pay on variable rate mortgages. It’s estimated that an increase in the base rate of 1.00% will increase monthly payments by £100 on a £250,000 mortgage over 25 years – an extra £1,200 per annum. Across the whole of the UK, mortgage payments could rise by up to £14bn.
Interest Rates and House Prices
Theory suggests that interest rates can also play an instrumental role in house prices. As interest rates rise, house price growth slows. From an investors point of view, were interest rates to rise by 1.00% and costs increase by £1,200 per annum, your net yields would consequently fall. If investors expect to achieve lower net yields, they will be less willing to pay over the odds for properties. Prices will need to fall or pause whilst rents increase, for investors to be able to achieve the same returns. After the Bank of England increased rates in mid-2018, house price growth fell to its lowest level since 2012.
Interest Rates and the Wider Economy
What is more, the nation as a whole has acclimatised to a low-rate environment. Laurie Suter, Head of Personal Finance at AJ Bell, says mortgage interest rates have been at rock-bottom for so long that many homeowners have never experienced higher rates and any rise will come as a nasty shock. And lenders aren’t slow to pass on rate rises. With a third of the UK’s 13.3 million mortgage accounts directly exposed to an increase in rates, many homeowners will experience a noticeable reduction in their disposable incomes. Something which may end up having wider economic repercussions as families begin to cut back their expenditure.
Why Are Mortgage Rates Expected to Increase?
Simply, inflation is showing signs of being higher and longer lasting than was initially expected. For most of this year, the Bank of England has stuck to the belief that recent increases to inflation were both manageable and transitory – that is, recent inflation was being temporarily caused by the re-opening of society. Unfortunately, recent data suggests that this is not the case.
Many economists now believe inflation will increase beyond the Bank of England’s top line expectations within the next six months. Fitch Ratings, one of the worlds big three rating agencies, expects CPI inflation to rise to 4.30% by the end of 2021 (compared to a forecast of 3.40% as recently as September) and to peak at over 5.00% in April 2022. However, it is worth noting that Fitch Ratings do not expect the base rate to increase by more than a conservative 0.50% in the coming year.
What is causing Inflation to Increase?
So, what is causing inflation to increase faster than expected? The most noticeable and headline grabbing increase has come from energy prices. Wholesale gas prices have hit record highs as tensions with Russia and increased demand from Asia have driven up international markets. It’s expected that the energy component of CPI inflation will rise by 1.00% in the coming months. It is not just energy prices that are increasing. Global supply chain pressures are pushing up manufacturing costs, with core goods inflation set to exceed 5.00%.
The problem with inflation is that it can sometimes be a self-fulfilling cycle. As costs rise and inflation erodes the purchasing power of incomes, workers are more likely to negotiate wage increases. Salary costs for companies will rise in response, forcing service-based companies to increase prices further. Growing evidence of a tighter labour market is amplifying concerns. It is this which is of key concern for the Bank of England and explains why the Monetary Policy Committee have signalled an imminent interest rate hike in the coming months.
How Have Banks Responded?
High street banks have already begun to withdraw their cheapest mortgage deals from the market in expectation of a hike in interest rates. Lloyds, the owner of Halifax and the UK’s largest mortgage lender, has increased the cost of some fixed rate deals, whilst Barclays has adjusted some of their fixed rate offers. Nationwide confirmed it is ‘reviewing’ its mortgage pricing.
Mark Harris, CEO of mortgage broker SPF Private Clients, highlights the sharp rise in Swap rates over the past couple of weeks. Five years swap rates have jumped from 0.66% to 1.24% since July, the cost of which will likely have to be passed onto borrowers. Barclays recently increased its five-year fix at 75% Loan-To-Value (LTV) from 1.21% to 1.31%. The lender is also raising its two-year fix at 60% LTV from 0.86% to 0.91%.
What Does this Mean for Landlords?
Admittedly, the theory and complexities of interest rates may be considered a dull affair by most. But in the highly leveraged world of property investment, they have huge practical implications. Prudent landlords with fixed rates coming to an end or with mortgages on a standard variable rate, may want to consider taking the opportunity to refinance onto a fixed rate to lock in the current historically low rates whilst they can. It may be worthwhile to work out how the cost of a 1.00% increase in interest rates across all of your mortgages compares to the cost of refinancing.
The author of this blog has opted to refinance a number of properties on 7-year fixed rates recently. Admittedly, such mortgages come with an interest rate premium, however they do lock in a palatable interest rate for the coming years.
Landlords looking to purchase a property may wish to take a more cautious approach. If interest rates do increase noticeably, the property markets current fizz may begin to dissipate. It may be prudent to err on the side of caution when bidding for properties, especially those where the net yield is low. The last thing you want is to overpay for a property as house price growth begins to slow, while also picking up a negligible net yield.
That being said, looking beyond recent history, the increase in rates is set to be relatively small. Even if rates were to rise to 1.00%, they would only be 0.25% above their pre-coronavirus levels. Equally, much as the Bank of England’s forecasts at the beginning of the year have proved to be wide of the mark, it could well be that inflation fears are overblown and interest rates won’t rise as high as expected. The saving grace is that, even if rates were to increase, rents outside of London have risen over the past couple of years – providing somewhat of a buffer to landlords.
References
Cubed Media Ltd t/a Property Road, 2021. Banks Pull Cheapest Mortgage Deals As Interest Rate Rise Looms.
Available at: https://www.propertyroad.co.uk/cheap-mortgages-pulled-interest-rate-rise/
Denns Publishing Limited t/a The Week, 2021. The Interest Rate Debate.
Available at: https://www.msn.com/en-gb/money/other/the-interest-rate-debate/ar-AAPyhhn?ocid=BingNewsSearch
Fitch Ratings Inc, 2021. Coming UK Interest Rate Rise Reflects Risks to Inflation Expectations.
Available at: https://www.fitchratings.com/research/sovereigns/coming-uk-interest-rate-rise-reflects-risks-to-inflation-expectations-22-10-2021
HM Land Registry, 2020. UK House Price Index annual review 2019.
Available at: https://www.gov.uk/government/news/uk-house-price-index-annual-review-2019
Office For National Statistics (ONS), 2021. UK House Price Index: March 2021.
Available at: https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/housepriceindex/march2021
Disclaimer: This ‘Landlord Vision’ blog post is produced for general guidance only, and professional advice should be sought before any decision is made. Nothing in this post should be construed as the giving of advice. Individual circumstances can vary and therefore no responsibility can be accepted by the contributors or the publisher, Landlord Vision Ltd, for any action taken, or any decision made to refrain from action, by any readers of this post. All rights reserved. No part of this post may be reproduced or transmitted in any form or by any means. To the fullest extent permitted by law, the contributors and Landlord Vision do not accept liability for any direct, indirect, special, consequential or other losses or damages of whatsoever kind arising from using this post.
