The higher rates climb, the harder you could fall... unless you have a safety net
With the cost of mortgages up 12 per cent this year, Melanie Bien sees what homeowners can do to keep a lid on repayments
Sunday 26 September 2004
Did you overstretch yourself when you took out your mortgage, getting the biggest loan you could afford at the time? Then you may now be struggling. With five interest rate rises in less than 12 months, taking the Bank of England base rate from 3.5 to 4.75 per cent, what was manageable then may be less so today.
If this is the case then you are not alone: three million people are struggling as a result of increases in their mortgage payments over the past year, according to research from broker Purely Mortgages.
Cheltenham & Gloucester's Housing Affordability Index for England and Wales re-inforces these findings. Homeowners are paying an average of 12 per cent more for their mortgages than they were this time last year, says C&G. The borrowers worst affected are those on their lender's standard variable rate.
As a result, homeowners living in the South-east are spending 48.5 per cent of their take-home pay on their mortgage, even though as a general rule payments should be no more than a third of your income. People in the South-west are also having a hard time, spending 47.3 per cent of take-home pay on their mortgage, while Londoners are spending 45.7 per cent.
But not everyone is prepared to sacrifice so much of their income to pay for the roof over their head.
Gary and Paola Davies are in the process of remortgaging to save money. The couple, who live with their five-year-old daughter Amy in Sherwood, Nottingham, are switching to Skipton building society's Stateside Tracker mortgage, when their current discount runs out next month. The Stateside Tracker currently has a payable rate of 3.6 per cent.
"I scoured the internet for the best discounted mortgages for a couple of months, but I couldn't find anything to match the deal I was on," says Mr Davies. "Then I came across the Stateside Tracker. The current rate is quite a lot lower than any UK mortgage; it's even below the Bank of England base rate."
The Skipton deal tracks the three-month US Dollar Libor (London Interbank Offered Rate) plus 1.87 per cent. The rate is "reset" four times a year, on the first days of September, December, March and June. There is a seven-year tie-in.
Mr Davies is not concerned about fluctuations in the rate. "I did look at fixed-rate mortgages as well but I struggled to find anything competitive. The hard thing is trying to forecast what will happen to the rate, as there isn't much information available on US Libor.
"But there is enough of a gap between US and UK interest rates for [the former] to go up quite a bit before I would be worse off."
Predicting what is going to happen with the cost of borrowing is never easy. But economists believe UK rates may be near their peak, with just a further quarter-point rise to come before the end of the year.
"The recent decisions made by the Monetary Policy Committee to increase rates are now appearing to have the desired effect," says Jon Pain, managing director of C&G.
"All the signs look positive, with the MPC now indicating that interest rates should peak at about 5 per cent to keep inflation in check."
Whether borrowing costs go up further or not, affordability should be at the forefront of your mind - whether you already have a mortgage or are contemplating buying your first home. Lenders may let you borrow up to four times your income (or even more) but it might not be wise to take on so much debt. While you may be able to handle it now, ask yourself what would happen if you lost your job or interest rates rose further. Would you be able to cope?
The key is to work out what you can comfortably afford. One way of budgeting is to opt for a fixed-rate deal. This ensures that for a set period - two, three, five or 10 years - your mortgage repayments will remain the same, no matter what happens to the base rate.
It's also worth building up an emergency fund to cover several months' mortgage repayments in case you lose your job or have other unforeseen outgoings to contend with, such as your boiler packing in or your car failing the MOT.
The Government provides no financial help with mortgage payments until you have been out of work for nine months, and even then it is capped and means-tested: you must be on income support or the jobseeker's allowance, and mustn't have savings of more than £8,000. Benefits cover only the first £100,000 of your mortgage, so if you comply with the above criteria but have a bigger home loan, you'll have to meet the shortfall yourself.
The amount of emergency savings you will need to tide you over will depend largely on your lifestyle and personal circumstances. But you should aim to have enough to cover at least six months of mortgage repayments.
Alternatively, you could take out insurance to safeguard the repayments if you are off work through injury or illness.
Income protection, also known as permanent health insurance, pays out a monthly sum in this case. You choose between an "own occupation" or "any occupation" policy: the first of these pays out if you can't do your normal job and is more expensive than "any occupation", which pays out only if you can't work at all.
The most comprehensive - and expensive - cover available is accident, sickness and unemployment (ASU) insurance, also known as mortgage payment protection insurance (MPPI). You don't have to take out all three elements and you may not need all of them. For example, your employer may offer accident and sickness cover, so you will need only the unemployment part.
However, income protection may be a better option than ASU as it is cheaper and pays out until you return to work. ASU pays out only for 12 months.
Whichever type of insurance you opt for, shop around for the best deal. Try online at www.insuresupermarket.com
HOUSEHOLD MANAGEMENT: A FINANCIAL SURVIVAL GUIDE
* Remortgage if you are on your lender's standard variable rate. If you have a fixed or discounted deal, remortgage as soon as this comes to an end. Ideally, start shopping around three months or so before the offer runs out.
* Choose a fixed-rate mortgage if you want to ensure that your repayments won't fluctuate.
* Consider how you will pay the mortgage should you lose your job or have to take time off work. Build up an emergency fund covering several months' repayments, or take out insurance.
* Don't stick your head in the sand. If you are struggling to pay your mortgage, it's better to inform your lender: you may be able to agree a more realistic repayment plan.
Independent Partners: Get fee-free expert mortgage advice and find the right mortgage deal for you.
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