Homeowners offered insurance against rate rises
Homeowners with variable-rate mortgages are being offered a new insurance product that promises to protect their payments from interest rate rises.
An estimated 7.5 million people are on either tracker mortgages or their lender's standard variable rate (SVR) deals, which means they could see their payments shoot up if the Bank of England increases interest rates.
The product, offered by insurer Marketguard, works by allowing the policyholder to pick a preferred ‘insured rate’ or excess above the Bank of England base rate. If the base rate and the specific mortgage rate rises above this excess, then the insurance will pay out to cover your increased repayments.
On a £100,000 repayment mortgage over a 20-year term, an excess of 1% over the base rate (currently 5%) could cost £43 a month when spread over the minimum 24-month period. However, you will have to pay two years worth of premiums upfront.
Policyholders can choose to set their excess at 1%, 1.5%, 2% or 2.5% above the base rate.
Marketguard, which launched the product on 2 July, says the product will help those people facing the prospect on moving onto a SVR when their fixed-rate deals expire this year.
Weighing up the risk
Whether or not you decide to opt for this product will largely depend on what you think will happen to interest rates over the next two years.
Andrew Montlake, a director at mortgage broker Cobalt Capital, says the Bank of England is unlikely to raise the base rate by more than 1% within the next two years because of the harm this would do to the already dented economy and housing market.
In addition, the base rate would actually have to rise by 1.25% before anyone would see a payout on this policy, as this insurance only kicks in once your excess has been exceeded.
Montlake adds: “Taking the policy cost into consideration, in effect you are adding 0.5% onto the mortgage rate to buy security. This seems to work initially at lower rates levels.”
For example, if you are on mortgage rate of 5%, increasing to 5.5% with this insurance, then this remains a cheaper option than going for a fixed mortgage where rates are currently higher.
However, if your variable mortgage has a rate of 6.25%, then adding this insurance would cost you 6.75%. Montlake says many borrowers could find a fixed-rate loan will give them the security they crave at a cheaper price.
“This is not a simple answer and will vary per person and the product,” he adds. “If you are really unable to remortgage and need that security then this might be a good option. The only way to determine if this is actually good value or not is to seek independent advice.”
Drew Wotherspoon, spokesman for mortgage broker John Charcol, agrees that borrowers looking for extra security against rising rates should think carefully before opting for this type of insurance policy.
"If you believe rates are going to rocket up in the foreseeable future then there will clearly be some merit in taking this product or a fixed rate,” he says.
Wortherspoon believes that interest rates would have to go up by well over 1% in two years for this policy to offer any value to homeowners.
He adds: “I do not believe that this is the future direction for rates, quite the opposite in fact. This product will therefore really only suit those who currently believe rates will go down but would value having some security in the background that takes care of all eventualities.”
The product may not be the cheapest way to secure against future base rate rises. For those people who can’t afford to risk the Bank of England raising rates, and for those stuck on SVRs, then this insurance might be worth considering.
Speaking to a financial adviser or mortgage broker should help you decide whether insuring your variable mortgage is worth it or not.
Things to bear in mind:
1. If you set an excess of 1% and the Bank of England base rate increases to 6%, then you will not receive a payout. The insurance only kicks in once your excess has been exceeded - therefore you are likely to have to wait until the base rate hits 6.25% before your additional repayment costs are covered.
2. The policy must be taken out for a full two years. After this time you can renew the policy, setting a new excess amount.
3. The premiums must be paid upfront, and the policy must be held for a minimum of two years. Therefore, using the 1% excess scenario above, the policy would cost you £1,032.
4. The product is also portable, meaning the policyholder can move home or lender without incurring any redemption penalties.
5. Depending on your specific circumstances, this insurance policy on top of a variable rate mortgage could end up costing you more than a fixed-rate mortgage.
Every mortgage lender has a standard variable rate of interest, or SVR, on which it bases all its mortgage deals, including fixed and discounted rate and tracker mortgages. When special deals come to an end, the terms of the deal usually state that the borrower has to pay the lender’s SVR for a period of time or pay redemption penalties. The lender’s SVR is, in turn, based on the Bank of England’s base lending rate decided by the Bank’s Monetary Policy Committee (MPC). Every time the MPC raises its rate, mortgage lenders generally increase their SVR by the same amount but when the MPC lowers its rate, lenders are often slow to pass this on or don’t pass on the full cut to borrowers.
A “traditional” mortgage, where the monthly repayments entail of repaying the capital amount borrowed as well as the accrued interest, so that during the loan period the capital debt is gradually paid off so by the end of the term the mortgage has been fully repaid. One advantage of a repayment mortgage is that it removes the risk of having a parallel investment (such as an endowment policy or pension), the performance of which is dependent on the stockmarket, such as with an interest-only mortgage.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.