Higher interest rates are coming – it’s time to fix your mortgage
The Bank of England has made it clear that interest rates will rise in 2015. So if you own a home, or plan to buy one, fix your mortgage now.
House prices (at least in London) seem to have hit a turning point.
In spring, prices went wild as buyers lost their heads. In the summer, the market slowed down as new rules hit lending. Now prices are starting to fall.
This is long overdue. London prices need to drop by at least 15-20% before they are approaching being affordable.
Yet a new report suggests that the Bank of England is confident that interest rates can go higher without causing too much pain.
We think they're wrong. Here's why, and how to protect yourself.
Low interest rates created the house price boom
This has fuelled the market in two ways. Firstly, it has kept mortgage costs low. The ratio of house prices to average earnings has never been higher. But the proportion of average income going on mortgage payments is only slightly above average.
Secondly, low rates have also reduced the returns that investors can get from other, less risky investments. So anyone with a lot of cash, on the hunt for income, has been tempted to invest in property for the rental yield.
If rates start to rise, the risk is that this could all go into reverse. Mortgage payments would rise, making high prices harder to afford. Investors would also find the sector less attractive if better, lower-risk returns became available elsewhere.
However, the Bank of England apparently isn't too worried about this. It reckons it could raise rates without too much pain, according to a recent report.
How does it reach this comforting conclusion? Survey data suggests that most households have actually been quite responsible in recent years. Rather than go on a spending spree, they've used the money saved on their mortgage bills to reduce their debts.
Only 4% of households spend more than 40% of their monthly income on mortgage payments. That's the level at which the Bank of England thinks there's a real risk of falling into arrears, or even defaulting. This percentage has also been falling for the past three years.
Similarly, only 14% of people say that they have trouble paying for accommodation. That might sound like a lot (it's more than one in eight, after all) but in fact it's the lowest level since the survey began in 1991.
So the Bank is quite sanguine. It reckons a small rise in rates would only increase the percentage of people in the danger zone to 6%. And they note that most people expect rates to rise in the coming years, so it shouldn't come as a big shock when they do.
There are a few caveats, but the overall message is clear: the Bank can raise rates without the world ending.
Higher interest rates could hit the housing market hard
But the threat of repossessions can't just be ignored. The problem with relying on surveys is that people tend to be too optimistic about their financial situation. A lot of people are probably underestimating the proportion of income they spend on mortgage payments. And many also assume that they will be able to work extra hours when and if mortgage bills start rising not something that can always be taken for granted.
The Bank also makes one crucial assumption that looks a bit dubious the idea that household incomes are going to jump by 10% over the next few years. It admits that if incomes grow more slowly than that, far more households will be in trouble.
Perhaps more to the point, if rates go up, it will make current prices even less affordable for new buyers. So even if forced sellers don't reach the levels seen in the early 1990s, those who do sell will find it very hard to offload their home without cutting prices.
Higher interest rates are coming take action now
This means that if you own a home, or are buying one, it makes a lot of sense to lock in low interest rates now, by getting a fixed-rate mortgage. In the summer this year, I took a look at the some of the longer deals, including some ten-year mortgages. There have been some changes in the market since I# wrote the piece, but you can still find a good deal at a historically very low rate.
And if you want to find out what our experts think will happen to the housing market next year, have a read of MoneyWeek's latest property Roundtable.If you're not already a subscriber, get your first four issues free here.