What would happen to mortgages if the base rate hit 3%, 5% or 7%?
Earlier this month the Bank of England increased its base interest rate by 0.5 per cent – the biggest single increase in 27 years.
It is the latest in a string of rises. The base rate has risen from 0.1 per cent in December to 1.75 per cent now, and the Bank’s Monetary Policy Committee has signalled it is willing to go further.
In its latest report the Bank predicted that inflation, more specifically the consumer price index, will soar to 13.3 per cent by the end of the year.
Mortgage rates have been going up due to the rising base rate, amid a backdrop of soaring energy bills and food prices.
Rate rises: The Bank of England has been increasing interest rates incrementally since the start of this year. Its base rate has increased from 0.1% in December to 1.75% today.
Since January 2022, interest on a typical two-year fixed mortgage has jumped from 1.3 per cent to 3.46 per cent, according to analysis from L&C Mortgages, increasing average monthly payments by around £159.
Understandably, borrowers are keen to understand how much further they might go.
Part of the answer may lie in the ongoing Conservative leadership campaign being played out in the background.
As the two candidates, former Chancellor Rishi Sunak MP and current Foreign Secretary Liz Truss MP battle it out to win over the Tory membership, the impact of their economic policies on people’s finances has been a topic of debate among experts.
Some say that the tax cuts proposed by Truss would lead to a base rate as high as 7 per cent.
While a base rate that high might seem unthinkable to younger borrowers, there is a historical precedent. UK interest rates have averaged 7.15 per cent between 1971 and 2022, reaching an all-time high of 17 percent in November 1979.
Capitalising on this, Sunak’s campaign has created an online tool to calculate how much a 5 per cent base rate would increase the interest on people’s mortgages.
What would happen to the base rate under a Sunak premiership is less clear.
We take a look at the impact future rate rises could have on mortgages and the property market.
Some say that Liz Truss’s tax cuts could hike the base rate to 7%, while what would happen to the base rate under a Rishi Sunak premiership is less clear
The situation today
Over the past few months the market has been quick to react to the rising base rate, with mortgage rates increasing even before the central bank’s announcements.
This is a problem for mortgage holders, says mortgage broker L&C’s David Hollingsworth. Borrowers have become accustomed to low rates and those who are coming to the end of a fixed deal will be in for a payment shock which will cause ‘some pain’.
Anyone on a tracker mortgage will automatically see their rate increase by the same amount as the base rate rises, while those on standard variable rates are also very likely to see costs rise.
However, 76 per cent of borrowers are on a fixed rate – and so the pain from higher rates will filter through to borrowers quite slowly as their deals come to an end and they remortgage.
Impact of a rise to 3 per cent
The average two or five-year fixed rate currently stands at around 3.5 per cent. Assuming that rates rises are broadly reflected in fixed mortgages, then that could mean an average of 4.75 per cent if the base level rose to 3 per cent.
Looking at SVRs, the current standard rate at Lloyds, to take on example, is sitting at 5.24 per cent after the moat recent 0.50 per cent increase.
If an increase to 3 per cent was directly reflected in SVR, then that would mean a rate of 6.49 per cent. However, Hollingsworth says that this is a too simplistic view.
‘Even the increases in SVR could become more measured if base rate was to rise so substantially,’ he says.
‘When base rate was mid-5 per cent in 2007, the SVRs were not that high and often operated around 2 per cent higher than base rate.’
A £150,000 mortgage at 5.24 per cent over 25 years would cost £897.99 per month. At 6.49 per cent the price rises to £1011.87 – an extra £112.88 a month.
A bump in the base rate, even to 3 per cent, would have a significant impact on the housing market according to Raymond Boulger, senior mortgage technical manager at broker John Charcol.
Experts say that while they don’t necessarily expect the base rate to reach 7%, such a rise could see house prices fall by up to a quarter as mortgages become unaffordable
‘Based on current market expectations of bank rate peaking at 2.5-3 per cent, I think that house prices will fall modestly next year, by about 5 per cent,’ he says.
‘But if the bank rate was to increase beyond 3 per cent, I would expect a greater fall. That would indicate inflation remaining high for longer than currently expected, with all the impact that would have on cost of living pressures.’
Impact of rate rises to 5 per cent and further
At 5 per cent, mortgage experts say that the market would begin to see significant stress.
According to L&C’s calculations, a rise in the base rate to this level would see SVRs climbing to 8.49 per cent, or £1206.83 a month on a £150,000 mortgage – increase of £308.84 on today’s levels.
‘An increase to a 5 per cent bank rate would make life very difficult for many borrowers when their fixed rates end’, says Boulger.
‘Many would not pass the affordability test to remortgage, but they would still be able to get a new deal from their lender with a product transfer.’
At 5 per cent, monthly payments on a £250,000, 30-year repayment mortgage would be £1,462.
The effect of a 7 per cent base rate on the market would be profound, says Boulger – and that is before the rising cost of food and bills is factored in.
‘Homes which are still affordable for many people at current mortgage rates of between 3 per cent and 4 per cent would become unaffordable and a combination of less buyers and forced sellers who couldn’t afford the new higher rates when their fixed rate finished would result in a large fall in house prices.’
The last major fall in prices was between the autumn of 2007 and the spring of 2009, when prices fell by 20 per cent. If bank rates rose to 7 per cent, Boulger says the UK could see a similar drop in prices of up to 25 per cent.
What about the affordability stress test?
In theory, most people with a mortgage should be able to afford a 7 per cent mortgage rate as they would have been stress tested at around that level when they took out the mortgage.
Last month the Bank of England called time on its mandatory mortgage affordability test – but most experts expect lenders to continue stress testing borrowers’ finances to similar levels.
However, broker Oli Pearce of Guild Mortgage Services says that calculation would not have accounted for the huge inflation concerns that are hitting households at the moment.
‘Although technically people are able to afford the borrowing level, they may not be able to actually afford the monthly payments,’ he says.
Pearce also mentions the impact rate rises will have on the rental market. Increasing interest rates increase costs for private landlords, he says, and that will be reflected in tenants’ rents.
‘The alternative is for landlords to start selling their stock off and reduce the availability of rental property further,’ he adds.
‘Landlords are already having to bear the brunt of improving energy efficiency in a property [to meet proposed regulations], changes in taxation and now potentially soaring mortgage costs, so tenants are likely to see their rental payments increase if it goes much higher.’
Best mortgage rates and how to find them
Mortgage rates have risen substantially as the Bank of England’s base rate has climbed rapidly.
If you are looking to buy your first home, move or remortgage, it’s important to get good independent mortgage advice from a broker who can help you find the best deal.
To help our readers find the best mortgage, This is Money has partnered with independent fee-free broker L&C.
Our mortgage calculator powered by L&C can let you filter deals to see which ones suit your home’s value and level of deposit.
You can also compare different mortgage fixed rate lengths, from two-year fixes, to five-year fixes and ten-year fixes, with monthly and total costs shown.
Use the tool at the link below to compare the best deals, factoring in both fees and rates. You can also start an application online in your own time and save it as you go along.
