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The truth about the mortgage timebomb

No need to worry about payment shock – overpay now or fix rates.
  • @simonnread

Outgoing Bank of England Governor Sir Mervyn King warned this week that homeowners in their thirties and forties are facing a mortgage timebomb.

He told MPs that households which are heavily in debt could struggle with increased mortgage repayments and other loans if interest rates rise.

With new Bank Governor Mark Carney hinting that a rise could well be in the offing, how worried should homeowners be?

"It's a bit late in the day for Mervyn King to be warning of ticking timebombs as he heads for the exit, but it is important that everyone considers how they will repay their mortgage, whether they are in their thirties or forties, or not," said Mark Harris, chief executive of mortgage broker SPF Private Clients.

The potential problem has built up because of the record low interest rates we've experienced in recent years.

That's left many people relatively comfortable with their level of monthly mortgage repayments. However, it may not have prepared them for the prospect of rising rates when mortgage demands could be so much higher.

"Sensible borrowers will be overpaying, using the money they are effectively saving each month," advised Mr Harris. "But even if you haven't been doing this, you can protect yourself from rate rises by taking out a fixed-rate mortgage. There are some very cheap deals currently available and a five or even a 10-year fix will give you some protection from rising rates over the medium to long term."

However, he added, it is important not to fix for longer than you are absolutely sure about or you could face a hefty early repayment charge to get out of the mortgage before the end of the fixed period.

David Hollingworth of mortgage broker London & Country also stressed the importance for borrowers to prepare for when an interest rate rise finally arrives.

"Those with significant mortgage debt that are worried about how a normalisation in interest rates would affect them can take some measures to ease the pressure," he said, also suggesting that fixing your mortgage rate could be a way to ease any potential payment shock.

"There are even some 10-year fixed deals available that insulate borrowers in the long term, although it's always important to consider whether more flexibility might be needed, he added."

For instance, the Yorkshire Building Society currently offers a 10-year, fixed-rate mortgage at 3.89 per cent, as long as you have a 25 per cent deposit.

But overpaying now is the most sensible way to reduce future mortgage worries, Mr Hollingworth agreed.

"Reducing the amount you owe by eroding the capital will mean a smaller mortgage when rate rises do come which will make it easier to deal with.

"In addition, it helps maintain some budgetary discipline in devoting more of your monthly income to the mortgage rather than getting used to very low rates as the norm and spending any spare cash elsewhere."

But he also cautioned against throwing every spare penny at the mortgage. "It's important to have an easily accessible, rainy day fund as well," he said.