Interest rate rises, and what they mean for you?
When interest rates start to go up, individuals who like to save their money are going to benefit. Banks and building societies often raise their interest rates based on the Bank of England doing so, meaning the amount you have in your savings account will go up. On the other hand, having a mortgage, loan or credit card debt means that any interest rate rises means the amount you’re borrowing rises depending on the conditions of the loan. This is where fixed-rate mortgages have an advantage: if rates increase then your mortgage repayments won’t fluctuate with the interest rates unless you plan to remortgage.
Though small interest rate rises don’t seem significant, they can have a big effect on the amount you’re paying. For example, if we take a £150,000 mortgage repayment, a 2.5% interest rate rise on the base rate would result in an extra £230 a month to be paid. Instances like this would require the mortgage holder to raise additional funds or cut spending or to switch to a new fixed-rate offer before the base rate changes. With this being said, there are ways in which we, as investors can turn these potential issues into opportunities.
1. Fixed-Rate Mortgages
Five and ten-year mortgages are available depending on the current market, meaning home-owners can rest assured their mortgage payments won’t go up for the duration of the loan. This method is a sure-fire way of protecting yourself against interest rate rises and will allow you to take any variables out of your mortgage repayments. The flip side to having this peace of mind is that you will often overpay for fixed-rate mortgages compared to a variable rate mortgage (also known as a tracker mortgage). Banks use fixed-rate mortgages as a form of insurance that they won’t vary your payments, but will charge you more, and tie you into them for longer as a result. This being said, if rates don’t increase, then you may well have spent much more on a fixed-rate mortgage that could have been utilised elsewhere.
If a borrower with a 30% mortgage took out a five-year fixed rate over a tracker, they would pay a 2.3% premium. Comparing an average 2.49% tracker with the 4.79% five-year fixed rate shows that by going with the fixed-rate, you add £181 a month to your monthly repayments on a £150,000 mortgage.
2. Tracker mortgages
If possible, it is best to vary your mortgage products between a tracker and fixed-rate mortgage so that you spread the risk. You may be restricted to whatever mortgage products are available at the time but to be safe, it is best to have a balance of fixed and tracker mortgages within your portfolio and to ‘self-insure’.
3. Self-insure approach
One approach is to compare the tracker and fixed-rate mortgage options, take the tracker but pay the difference amount each month into a savings account.
Essentially, you are creating your own insurance policy against rate rises as you are paying the fixed term rate at the same time as covering yourself for any potential increases. If the rate rises, you have the same level of cover as if you had been paying the fixed-rate. If the long-term tracker ends up costing less, then you will have a nice pot of cash in your savings account.
4. Equalise
The last option is to use all three of the strategies mentioned above across different markets to limit against the effects of any major market shifts and average out the profits/losses from each option.
We hope you’ve found this article useful in explaining interest rates and how they can affect your investments. If you would like to know more about Nichol Smith Investments, click on the link below to book a call.
