The Bank of England stunned market onlookers last week by voting to keep its Base Rate of interest at 0.1%, the level that it has been at since the beginning of the pandemic.
While most were expecting an increase to curb rocketing inflation, the Monetary Policy Committee instead voted to push back an increase until at least December.
Many banks, having feared an imminent increase, had already begun to revise rates upwards, indeed several High Street banks also revised their rates just hours after the chancellor announced the budget last week, ahead of November’s Base Rate announcement.
All eyes, therefore, will be on the next MPC meeting, scheduled for December 16th. But what exactly will an increase in Base Rate mean for you and your mortgage? Andy McBride, director of Professional Contractor Mortgages, explains today.
“It is fairly clear that a rate increase is just around the corner, with many shocked that we haven’t had it already. While Bank of England Base Rate only affects a relatively small section of new mortgage lending – those on a tracker mortgage linked to Base Rate – there will be substantial knock-on effects throughout the market.”
“Rapid house price inflation following the pandemic means that buyers are more stretched than ever before when comparing borrowing against income levels. Affordability is a key measure in mortgage underwriting and lenders use measures to stress test the effect of a rate increase when looking at whether to agree a loan or not.”
Stress testing is an often-overlooked area of the underwriting process, designed to cater for the situation that we are anticipating right now. In simple terms, a bank needs to satisfy themselves that not only can you afford the mortgage now, but that you can afford the mortgage if interest rates were to rise.
“Because of the nature of stress testing being a ‘worst case scenario’, many people overlook how important it is, largely because it has seldom ever come to fruition, given that lenders look at things pessimistically” continues McBride. “The reality however is that we could soon see interest rates rise to the sort of levels that lenders use to test affordability, meaning even a small increase in rates could then impact mortgage approvals using even higher stress testing.”
The Office for Budget Responsibility expects that the Base Rate will increase to 0.75% by the end of 2023, meaning a knock-on increase in real terms of 13% on mortgage interest rates, year-on-year.
With Base Rate at its current level, economists estimate that the average homeowner with an 80% mortgage spends nearly 40% of their median income on servicing the debt, an average of just over £800 per month. With fears that Base Rate could rise even further than expected, an increase to 1.5% would see monthly costs jump to nearly £1,000, nearly half of median income.
“With inflation already exceeding predictions, it isn’t entirely unlikely that Base Rate will do the same” concludes McBride. “Should that happen, it will mean that homes would, on average, be less affordable than at any point since the 2008 crash. At a time when the jump to the bottom rung of the property ladder is the greatest it has ever been, we run a real risk of future generations being incredibly unlikely to become homeowners.”