How to avoid becoming a mortgage prisoner
With interest rates bound to rise eventually, homebuyers should start thinking now about the best way of not suffering a financial shock, says Simon Read as he consults the experts
With warnings that more than two million households are in danger of becoming mortgage prisoners when interest rates rise, what can you do to avoid disaster?
The rule is to prepare now for future rises. If you can find an affordable fixed-rate deal, that will give you the certainty of knowing how much monthly repayments will be for up to 10 years ahead. And if rates rise rapidly you'd end up saving a fortune in interest charges.
If you're already on a good deal, you could start to prepare for future rate rises – and increased repayment demands – by making monthly overpayments now, if your deal allows you to. Then when rates do go up you won't experience rate shock. And the overpayments will have cut the amount you owe on your mortgage, which means you'll save future interest charges and potentially be able to remortgage at a better rate because you have more equity in your home.
We asked mortgage experts what you should be doing if you're worried about future rises…
What should I do if I'm on a standard variable rate?
"Those on a typical standard variable rate [currently around 4.75 per cent] should be considering a move to save money," advises David Hollingworth of London & Country Mortgages. "However they can also take the opportunity to build in some protection against future rate rises. It's still possible to fix for five years at just below 3 per cent. Norwich & Peterborough BS offers a five-year fix at 2.98 per cent to 75 per cent loan-to-value with a £1,295 fee.
"Some borrowers will be on lower SVRs and may be reluctant to give up on these rates [such as the old Nationwide base mortgage rate, currently 2.5 per cent]. They could perhaps give themselves a stress test to see how comfortable they would feel if rates were to rise by a certain margin. That may point them toward a fix but even if they stay put on the variable deal they could look to overpay in the meantime to make the most of the low rates and pay down the mortgage more quickly."
Mark Harris, of SPF Private Clients, says: "Compare your SVR with the alternatives. If your SVR is 5.99 per cent or more, there are plenty of cheaper fixed-rate options. However, those sitting on historic super-low SVRs may find that the long-term fixes out there are less attractive so may decide to stay put for now and benefit from that cheap rate for longer.
"If you do this, consider overpaying with the money you are 'saving' each month; this will reduce your outstanding mortgage faster plus ensure you get used to paying a higher mortgage amount each month for when you do move on to a higher fixed rate."
Ray Boulger of John Charcol says: "Providing you have at least 10 per cent equity in your property and you don't plan to sell your home in the near future, switch to a fixed rate. Although a little dearer than two- or three-year fixes, five- or 10-year fixed rates offer protection from when rates are actually likely to rise. It is now possible to get a 10-year fixed rate with early redemption charges for just the first five years."
What should I do if I've got three to six months to go on a fixed-rate mortgage?
Adrian Anderson of Anderson Harris says: "Ideally, you should already be looking around to see what sort of product you can get at the end of your fixed rate. Speak to an independent broker to see what options are available, particularly if your income has fallen or you've become self-employed since taking out the mortgage.
"If you have an interest-only mortgage, the options will be more restricted than they were when you took out your loan, particularly if you have a high loan-to-value. With the new Mortgage Market Review rules, lenders will be looking closely at outgoings so start reining in any non-essential spending to improve your affordability."
Boulger says: "Most mortgage offers are valid for between three and six months and, in any case, it is currently usually taking at least two weeks to get a mortgage offer, so it is not too soon to apply for a new fixed rate."
Hollingworth says: "This type of borrower should be very focused on what they want to do at the end of their current deal. Gathering together paperwork and understanding the breakdown of their income will be helpful when applying for a new mortgage, especially under the new MMR rules. A mortgage offer will typically be valid for three to six months so it makes sense to commence the application process in advance of the current deal ending, in order to secure a deal and ensure a smooth move across once the current deal expires."
What should I do if I've got six to 12 months to go on a fixed-rate mortgage?
Boulger says: "Start getting advice on the fixed-rate options when the period left on the current deal has fallen to seven months."
Hollingworth says: "This borrower will soon find that they will be ready to remortgage and should be thinking ahead so that they can make a smooth switch to a new rate. In the meantime they may also find that there are some expenses that they can seek to reduce, such as paying off other debt commitments like credit card balances or personal loans. Reducing outgoings will make it easier to meet affordability requirements now in place."
Harris says: "If you have several months to go before your mortgage deal reverts to SVR, shop around and reserve a product to complete on in six months. During that time you should ensure that your personal paperwork is in order, such as payslips, P60s, SA302s for the self-employed, interest-only repayment strategies and so on."
What should I do if I've got a year or two to go on a fixed-rate mortgage?
Anderson says: "With mortgage offers generally lasting six months, it is too early to apply for a new deal. However, it isn't too early to take a look at your financial situation and see whether it can be improved. Consider overpaying each month to take advantage of a relatively low interest rate and improve your equity stake in the property for when you come to remortgage.
"If you have an interest-only mortgage with no repayment vehicle in place, think about how you will repay the loan as any lender will want to see evidence of this when you come to remortgage. Consider whether you have savings that would be put to better use in reducing the loan-to-value on your mortgage to make you more attractive to lenders when you do come to remortgage."
Harris says: "Most fixes will carry early repayment charges during the fixed-rate period. These vary from lender to lender. Although cheaper fixes may be available, unless the lender waives the ERCs then the penalty incurred will offset any potential savings so you may as well stay put for now."
Hollingworth says: "The approach for these borrowers with longer fixed rates will be largely the same. They could consider whether it would make sense to switch away from the existing deal to a fixed rate but that needs to be approached carefully. The existing deal is likely to carry an early repayment charge, which could amount to thousands of pounds. Moving to a new rate now could give protection for longer but the benefit could be wiped out by any early repayment charge that applies.
"If it isn't worth switching it makes sense to consider overpaying in the meantime. Most deals allow some overpayment to be made without an early repayment charge, typically as much as 10 per centa year. This will help to reduce the level of mortgage debt and put them in a better position when it is time to review the rate."
Boulger says: "As rates will probably not increase much over the next year, it is unlikely to be worthwhile paying early redemption charges to come out of the fixed rate early. I would advise assessing options when the period left on the current deal has fallen to seven months."
What should I do if I've got three years or more to go on a fixed-rate mortgage?
Anderson says: "Congratulations – you've got certainty for a reasonable period of time. However, you shouldn't rest on your laurels as when you do come to remortgage in three years the chances are rates will be higher so your mortgage will cost more. Put yourself in a stronger financial position by overpaying each month if you can and reducing your outstanding mortgage.
"With most lenders letting you overpay by up to 10 per cent of the mortgage each year, if you are thinking about going self-employed now is a good time as most lenders will want to see at least three years' worth of accounts when you come to remortgage. So you would be giving yourself time to generate these."
Boulger says: "Get advice from a good independent mortgage broker as in a few cases it can be worth paying the early redemption charge to switch to a new rate. For example, a fixed rate taken out two or three years ago might have been at a particularly high rate because at that time the loan-to-value was very high.
"With some of the mortgage since paid off [assuming a repayment mortgage], plus factoring in the recent increase in house prices, it might be worthwhile paying the early redemption charge to switch to the cheaper rates available at lower loan-to-values.
"Some borrowers with a tracker mortgage which has early redemption charges will have what's called a drop-lock option, which allows them to switch to one of their lender's fixed rates without incurring the charge. That could be a good option."
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