Evanomics

Fixed-rate pickle

• Evan Davis | Notes on Real Life |
• 6 Jun 07, 10:23 AM

All good things must come to an end. And concern is brewing for people who took out fixed rate mortgages two years ago, and who are now coming off them to find rates far higher than they have been used to.

In 2005, according to the Council of Mortgage Lenders, about 1.3 million people took out fixed rate mortgages, at an average rate of 5.18%. Most of those people will probably come off their fixed rate this year and fall on to a stinging standard variable rate (the current average is over 6%) or they will have to re-mortgage at today's rates.

There are many options for re-mortgaging, but typically a good new two-year fixed rate will charge around 5.5%. Better offers than that are available, but they typically come with high fees that offset the lower rate.

This phenomenon of the re-mortgage blues has already started to bite, but so far most people have been leaving fixed rates of above 5% and so their shock is not quite as extreme as it might be, particularly if they shop around and get one of the better deals available now.

But it will get worse as months pass, because it was later in 2005 that rates bottomed out. In November 2005, 148,200 people took out fixed rate mortgages at an average 4.95%. That was after the Bank of England cut interest rates in August 2005, (a poor decision in hindsight, analysed below).

But if 4.95 was the average, it means roughly half that number took out mortgages at rates below that. They will face a shock. Hopefully they have been anticipating it and saving a bit already.

While this of course matters to the many people who moved house or re-mortgaged two years ago, it is also of macroeconomic consequence. Sixty-one per cent of new mortgages in 2005 were fixed rate, while only 10% were on standard variable rates. This means interest rate rises may have a somewhat delayed effect, and that might justify a caution in over-doing it on interest rate rises too quickly.

Only when the fixers have re-mortgaged can we be sure where we are.

It is worth mentioning, however, several things that might mitigate the suffering of those coming off their fixed rates.

1. The mortgage market is becoming more competitive and lender margins are being squeezed, so the full cost of new offers may not reflect the whole rise in variable rates of the last year. It is not difficult to get a new fixed rate mortgage charging below base rates, with the bank hoping to make some money back from the customer once the fix expires. Clever buyers can avoid handing those profits to the bank by re-mortgaging quickly and not letting themselves pay for the full standard rate.

2. The banks are choosing to re-base their mortgage pricing away from interest payments, towards fees. Indeed, many of the rates have barely risen at all, with the fees soaring from a couple of hundred pounds up to a couple of thousand.

Now that is of no long term benefit to the customers, but for for cash-strapped fixers in an immediate pickle, the advantage of the fee is that it can be added to the mortgage rather than paid upfront. (In fact, Credit Suisse believe 80% of borrowers choose to postpone payment of the fee in this way.) , In the short term, a £1,000 fee added to a mortgage implies an extra payment of only £5 a month.

3. People re-mortgaging this year have probably enjoyed double digit growth in the price of their house in the past two years, and so can aim to get a mortgage with a lower loan to value ratio than their expiring one, on better terms.

4. People re-mortgaging have probably seen their income rise in the past two years - wages usually go up a per cent or two faster than inflation. That would mean there is a little extra money to help finance the new mortgage.

5. People who are desperate, can minimise monthly payments by switching to an interest-only mortgage to alleviate the pain, if they expect their income to rise over time. Indeed, The interest-only phenomenon is catching on - in March, 27% of home movers took out interest-only mortgages with no stated method of re-paying the principal. One assumes that there are unstated methods of re-paying.

For all these points though, even if the great fix-switch that is underway is tolerable, it will not be very pleasant.

Imagine someone who overstretched themselves two years ago, with a 4.75% fixed rate that amounted to 30% of their disposable income.

The mortgage payments will rise by 16% or so, (4.75 to 5.5), taking the payments from 30 to 35% of their old income.

If their income had risen by 8% in the two years, their new payments would be 32.2% of their enlarged income. They would have to have spend most of their last two years of pay rises on meeting their higher mortgage payments. Just at the time they were probably hoping the early-homeowner overstretch would be easing.

For a while we've said: "Why are these higher interest rates not having more effect?"

Maybe we just didn't wait long enough.

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