Mortgage time bomb warning for homeowners
Outgoing Bank of England governor Mervyn King warned in his final speech to MPs on Tuesday 25 June 2013 that homeowners in their thirties and forties might be in an "unsustainable position" should interest rates rise.
He said: "If there are changes around the world that lead long-term interest rates to go up – it's unlikely, but if they do go back up quickly – then some of those households will have levels of debt that won't look so attractive given the new lower level of house prices."
King told MPs that during the current era of low interest rates – the Bank of England base rate has been at 0.5% since March 2009 - consumers should have been paying off mortgages rather than taking on more debt.
Homeowners in the UK have an average balance of almost £100,000 outstanding on their mortgage, according to research undertaken by Moneywise earlier this year.
The findings, from the Moneywise Consumer Opinion Survey of 20,000 people, revealed that the average outstanding home loan stands at £95,883.
The average mortgage balance offers a glimpse into the size of loan British households are trying to service at present – a time when inflation is easily outstripping wage growth.
The latest labour market figures from the Office for National Statistics indicate that annual wage growth stands at 1.8% compared to inflation running at 2.7%. This means people's real take-home pay is being seriously eroded by the cost of living.
Were interest rates to rise, the impact on cash-strapped households could be devastating.
David Hollingworth, mortgage expert at London & Country, says that with an average standard variable rate of 4.75% on a repayment mortgage of £95,883 over 20 years, monthly repayments would be £619.62. These would rise by £54 to £673.18 if the SVR were to increase by 1 percentage point. But if the SVR rose by 2 percentage points, the mortgage repayments would rise by almost £110 to £729.06 a month.
To put that in context, research from Halifax published earlier this year showed that half of all households (46%) would struggle if they had to find another £99 a month in their budget; one in four (26%) would be stretched by an increase of £49; while 13% said finding just £24 a month more in their budget would leave them stretched.
Canadian Mark Carney takes over from Mervyn King as governor of the Bank of England on 1 July 2013.
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.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
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.