Mortgage mayhem – what options do borrowers have now?

Alice Haine, Personal Finance Analyst at Bestinvest, the DIY investment platform and financial coaching service, comments:

As the dust settles following the Bank of England’s decision to raise interest rates by 50 basis points in a desperate battle to bring rampant inflation back in line, many homeowners and first-time buyers will have spent the past few days mulling their mortgage options.

Britain is now in the grip of the worst mortgage squeeze since the housing crash of the early 1990s. While the average fixed rate was significantly higher at around 13% in 1990 compared to current levels of 6.26% for a two-year fix and 5.87% for a five-year fix* – the size of the loans households take on today relative to their incomes is much bigger.

This is why the mortgage shock feels very real for many. Those refinancing are finding a much higher proportion of their post-tax income now swallowed up by costly repayments. More money spent servicing mortgage repayments means less money to spend elsewhere, which is straining household finances – already battered by the cost-of-living crisis – to the max.

The BoE took aggressive action last week and made it clear it will do so again if needed – even if that means plunging the country into a recession - as it strives to bring stubbornly high inflation closer to its target of 2%.

As the cost-of-borrowing crisis heats up and the Government shies away from rolling out a direct support package, instead introducing the Mortgage Charter for lenders and financial organisations to help borrowers in distress, many will be wondering how their finances will cope.

Not everyone is affected equally as the impact of raised interest rates depends on your loan-to-value ratio, the length of the mortgage term, the mortgage rate applied and whether you are locked into a fixed or variable rate deal and the date that deal matures.

As soaring mortgage rates and rising living costs force more sellers to accept lower offers to secure a property sale – with 42% of sellers accepting discounts of 5% or more on the asking price of their home in the week ending June 18, according to Zoopla – Alice Haine outlines the options for first-time buyers, homeowners looking to refinance and those locked into long-term deals.

Borrowers on variable mortgages, where rates are more closely aligned to the BoE’s base rate will be feeling the most pain. There are three types of variable rate categories: trackers, standard variable rates (SVRs) and discounts.

 Tracker mortgages, which are directly tied to the BoE’s base rate, are causing the biggest headache as borrowers receive an instant hit to their finances every time interest rates increase. These products are great when interest rates are falling, but not when they are rising. Switching from a tracker deal can incur an exit penalty, but it might be worth it if you can secure a better fixed-rate deal: so, do the calculations carefully. Those willing to take a gamble that interest rates will fall next year might gain over the medium-term, but it will require a strong stomach to lock in a variable rate today when there is talk of interest rates rising to 6.25%.

Those on a standard variable rate (SVR) - the default mortgage that borrowers move onto after finishing an introductory fixed, tracker or discounted deal - could also see their repayments rise in line with a base rate hike if the lender passes that on. SVR mortgages are typically the most expensive, with average rates now hovering above the 7.5% mark and some products significantly higher.

Anyone on an SVR should consider switching to a fixed rate deal, if possible, to lower their repayments, while anyone whose fixed product is expiring soon should look to line up their next mortgage as soon as possible to avoid ending up on their lender’s SVR.

The one benefit of an SVR is that there is typically no early repayment charge, so the mortgage can be paid back in full at any point without incurring a penalty. If you know you will have the funds to clear the mortgage in the next few months, then it might be worthwhile sticking with the higher rate.

Even those locked into a discounted mortgage - a variable mortgage with a discount on the lender’s SVR for a fixed period - could see an increase if the lender passes it on.  Discounts tend to apply for shorter periods of two or three years, but take note: different lenders have different SVRs, therefore it is not always the size of the discount that is key but sometimes the underlying rate.   

Deciding whether to choose a variable or fixed-rate deal is the big question of the moment. Benchmark interest rates are expected to rise further from here before possibly falling next year and a fixed rate offers protection against future rate hikes and certainty over what you need to pay every month.

Someone whose finances are very tight should avoid the risk that comes with a variable mortgage in the short term, but those with spare cash may want to take a gamble on a discount or tracker if they think it might work out cheaper in the long run if interest rates really do fall in the next year or two. A good independent mortgage broker is the best person to guide buyers through the process.

Most mortgage borrowers are on a fixed rate, with the impact of higher mortgage rates set to take time to filter through as many as still locked into ultra-cheap rates taken out before the BoE began hiking rates in December 2021.

By the end of 2026, almost all of the 8.5 million British households with a mortgage will have switched on to a higher rate with annual mortgage bills expected to be £2,000 higher on average compared to December 2021, according to the Resolution Foundation.

How badly a household is hit by higher fixed mortgage rates will depend on whether they are buying for the first time, looking to refinance in the next 12 months or still have some time to go on a long-term product:

• First-time buyers

Affordability is the big challenge for first-time buyers as rising mortgage rates mean your repayments will be higher, essentially reducing the amount you can borrow. Those determined to buy should be wary of low-deposit mortgages as this could leave them very exposed if house prices plunge dramatically. The bigger the deposit they can put down the better, as this not only secures better rates but also offers some protection in a falling housing market.

Now is the time to negotiate hard on the asking price. The housing market is in a precarious position as high interest rates make it harder for people to secure a mortgage and some buy-to-let investors scurry to sell in the face of hefty increases in borrowing costs. Those with a mortgage offer already in place will be in a stronger position as they can move faster. Go in low with an offer and haggle hard as the less you borrow, the less vulnerable your finances will be.

If interest rate rises seem too scary, the other option is to put buying plans on hold until the situation stabilises or property prices fall. With higher mortgage rates set to cause considerable pain for many, more houses could be listed as people look to downsize or exit the property market completely, easing the supply shortage for buyers.

Interest rates are expected to jump again in August and potentially peak at 6% or higher this year, which means first-time buyers could be locking in a deal at a time when rates are spiking. Waiting until the situation eases could be a good move though renters aren’t immune to the mortgage chaos either as landlords will look to pass on the extra costs to tenants.

Choosing whether to go ahead now is a difficult decision, which is why a reputable and patient independent mortgage broker can guide first-time buyers through the process, laying out all the options for their situation.

One option is to extend the mortgage terms to 35 or 40 years with the proportion of first-time buyers taking out a mortgage with a term of more than 35 years hitting a record high in March at 19%, according to UK Finance.

While it can be an effective way to lower repayments and ensure a desired home is affordable, the buyer will pay more in interest charges making the cost of the mortgage significantly higher. Someone borrowing £250,000 with a 25% deposit would pay an extra £50,000 for a 35-year mortgage compared to a 25-year product, according to Zoopla. Spread the same mortgage over 40 years and the additional cost rises to £80.000.

Another way to lower repayments is to apply for a 100% mortgage. There are a handful of deposit-free mortgages available that help people out of the rental trap faster as they don’t have to spend time saving. However, they typically come with very strict lending criteria and there are risks.

Housing prices are likely to fall in the coming months putting someone with a 100% mortgage in danger of ending up in negative equity where the house is worth less than the amount they owe. This effectively traps people into their mortgage and raises the risk of repossession if they cannot keep up with repayments – though the Government’s new Mortgage Charter offers some short-term protection here.

• Borrowers refinancing in the next 12 months 

Around 800,000 homeowners are set to come off fixed-rate deals in the second half of this year, and about 1.6 million next year**, with all at risk of moving onto an ultra-expensive variable rate if they don’t act quickly to secure a fresh deal.

While hundreds of mortgage deals were pulled from the market in recent weeks as lenders repriced in the face of higher interest rate expectations, there are still deals available for all deposit levels.

There is also the possibility that mortgage rates may ease back. When mortgage rates last shot up in the wake of the mini-Budget, they later stabilised and fell back a couple of months later. If the next inflation figures are more upbeat, indicating that the BoE is finally winning the battle against rising prices, then the financial markets might lower their interest rate expectations, improving the outlook for mortgage rates.

Borrowers nearing the end of a fixed-rate deal can lock in a new deal up to six months ahead with any lender under new measures set out by the Government’s new Mortgage Charter. They can also apply for a better deal right up until their new term starts, so tracking the market carefully will be key.

Those with longer than six months until the expiry of their deal should use the time to get their paperwork and finances in order. The best mortgage deals can come and go very quickly, so gathering documents together to ensure you can move fast will speed up the process. These can include three months’ bank statements and/or payslips, proof of address for the past three years so utility bills are useful for that. Your driving licence or passport, details of your regular expenditure, proof of any bonuses or commission and your P60.

Deciding whether to lock in a two or five-year fix will be tricky at such an uncertain time. Five-year fixed rate mortgages may currently be lower than two-year products but with mortgage rates so elevated and some expectation they will fall next year, a two-year product could provide more options.  Alternatively, a five-year deal offers certainty on repayments for a longer period, which can be comforting for some as they can then plan their finances around that figure.

• Mortgage holders locked into longer-term fixes

Borrowers who signed up for longer-term deals before interest rate rises began at the end of 2021 can enjoy lower repayments for some time yet but that does not mean they should sit back and relax.

When their product eventually matures, it is highly unlikely that interest rates will be as low at the point they started their current deal – with some securing rates as low as 1% against the backdrop of UK interests being cut to the lowest level in over 300-years. Instead, they should prepare for the worst and start preparing for that moment when their mortgage costs will jump.

One way to get ahead of a rate rise is to overpay. Lenders offer their most competitive deals to those with large deposits or equity stakes in their property, so if you are fortunate to have spare savings, now might be a good time to pay down your mortgage. This not only reduces the balance, but also the amount of interest and, more importantly, helps borrowers adjust their finances to a larger monthly repayment before it becomes mandatory.

Make sure your lender allows penalty-free overpayments and check how much you can overpay by. While someone on an SVR product typically has no limit, most fixed-rate mortgages and some tracker mortgages have an annual overpayment limit of 10% of the total outstanding mortgage balance.  Mortgage providers calculate this differently so speak to your lender to check the exact amount for your product.

Getting your finances in order is also important. Clearing unsecured debts, such as a personal loan, credit card or overdraft will free up vital cash that can go towards mortgage costs.

At the same time, don’t get so distracted by the prospect of higher mortgage costs that you neglect your other short and long-term savings. Saving for short-term goals, such as a holiday, or long-term goals such as retirement are still vitally important. Neglecting ISA saving and pension saving could leave people with a pension gap when they come to retire, with the potential of more people working for longer to make up the shortfall.

One option for people remortgaging is to sell up and downsize – a preferential option for those with sizeable equity in the house whose children may have moved out. Selling up, clearing the mortgage debt in full and buying a cheaper property that requires no borrowing may feel like a solution, though achieving the desired price level for the sale may be tricky if house prices fall considerably.

Those aged 55 and over might also consider taking their 25% tax-free lump sum from their pension to clear their outstanding debt. Paying off a home loan as you near retirement might make sense, particularly if you plan to retire early and don’t want to be saddled with high living costs. You can even access this money and continue to work and contribute up to £60,000 gross to your pension savings every year.

Mortgage arrears are on the rise, with 750 homeowner mortgaged properties taken into possession in the first quarter of this year, 50% more than the previous quarter**.

Thanks to the Government’s new Mortgage Charter, borrowers have more protection if they cannot afford their repayments. Anyone worried about their situation can contact their lender and ask for information and support.

Solutions could include switching to an interest-only mortgage for six months, extending the mortgage term with borrowers able to go back to their original terms within a six-month period and not have their credit score negatively affected.

While interest-only is okay for the short-term, as it reduces the monthly payment, this comes at the expense of reducing the mortgage. Leave it too long and switching back will only get harder.

Payment holidays can also be useful for short-term relief if finances get very tight, but that interest will be added to the mortgage, so there will be a longer-term cost.

Struggling mortgage borrowers also have more time before their properties can be seized. Those in severe mortgage distress can prevent their home from being repossessed for 12 months.

For those in real trouble, who might find chatting to their lender daunting, debt charities can provide useful information on what steps to take to get back on track, rather than falling into deeper strife.

* According to Moneyfacts

** According to UK Finance