The economic climate looks set to change this year, with interest rate rises looking increasingly likely. Most households will find themselves directly affected. Waiting with most dread are the variable-rate mortgage-holders who are far better off if the bank base rate stays where it is at 0.5 per cent. But there are also many households that are dependent on their savings, and will be hoping that rates will rise soon. Keeping their fingers crossed are people with credit cards and those who are thinking of buying an annuity. Below, we explain the implications for all these groups.
The markets have been betting on a June rise and, quite possibly, a second one by the end of the year. Such a scenario is entirely feasible under the Inflation Report published by the Bank of England this week. Its "central projection" sees base rates rising to 0.75 per cent in four months and to 1.0 by the end of the year. Rates then go up to 2 and 3 per cent in 2012 and 2013.
However, Bank of England Governor Mervyn King injected some uncertainty. Although admitting that rates must rise at some stage, he emphasised that the rate-setting body, the Monetary Policy Committee, was not tied to the Inflation Report. Despite this uncertainty, the Consumer Credit Counselling Service (CCCS) does not want people to worry unduly. "The initial increase is probably going to be pretty slight," says spokeswoman Frances Walker.
Nevertheless, Eastbourne CCCS, debt adviser Maggie Kirkpatrick says that people are frightened of the increase. But she emphasises that they should not panic, provided they keep in touch with their creditors. "The bad days when creditors did not listen have gone," she says. "If you speak to your lenders, they are much more likely to come to a reasonable compromise than they were in the past." So even if you are one of the 28 per cent of adults who, according to Shelter, spend more each month than they have coming in, you could still negotiate your way through what is going to be a tough year or two.
Lenders and advisers are expecting a rush into fixed-rate loans as homeowners try to limit their exposure to rising interest rates. "You will see a lot of people looking to grab a fix now," says David Hollingworth of London & Country Mortgages. London & Country has seen a 40 per cent rise in the number of enquiries so far this year. Someone on a floating rate is potentially highly exposed. Someone paying £711 a month on a £150,000 repayment mortgage now, on a 3 per cent rate, would pay nearly £60 more a month if rates rise 0.75 per cent, and £165 more if rates rise 2 per cent.
About half of new mortgages being applied for now are for fixed rates, but Hollingworth thinks that proportion could rise "to 60 per cent or even higher". While fixed rates are being pulled daily by lenders, and being replaced with deals at slightly higher rates, Hollingworth recommends two-year deals at below or around 3.25 per cent ("Anything around that mark is good") and five-year deals around 4.5 per cent ("probably a good rate"). Given a choice between the two, he would tend to opt for the latter: "If you are not planning to do anything or go anywhere in the next five years, then a 4.5 per cent rate would strike me as a good deal."
People staying on trackers need to be confident that they can handle 6 per cent rates within a few years. Since typical tracker margins are about 2 per cent above the base rate, those trackers would get to 6 per cent if the base rate rises to 4 per cent. Borrowers in the toughest position could be those who cannot afford much higher monthly payments but do not have a low enough loan-to-value ratio to qualify for a fix. An option, where possible, is to start paying off some of the capital. Since there are strict limits, in many deals, on the monthly amount that can be repaid without incurring penalties, it is best to start early to take advantage of those limits.
One piece of good news here is that rates on plastic and other unsecured credit are not expected to rise. "Secured credit has never been particularly tied to interest rate rises," says Frances Walker of theCCCS. "We would not expect to see credit card rates go up." People are borrowing less these partly because they are being more cautious and partly because loans and credit are harder to find. The average debt of CCCS clients was nearly £22,500 in 2010, 12 per cent lower than in 2008.
Savers hoping for significant increases in their interest rates could be disappointed. Banks and building societies have topped up many of their products beyond what the current 0.5 per cent base rate would warrant and, says Michelle Slade, of Moneyfacts, "we will see that spread start to shrink again. It is unlikely they will pass on interest rate rises in full on every account." While the rate on one-year bonds was an average of 0.21 per cent above the base rate in 2007, one-year bonds typically offer 2.66 per cent now, equal to 2.16 per cent above the base rate.
There will be areas of particular competition on rates. The traditional February and March ISA (Individual Savings Account) season each year usually sees banks and building societies offering eye-catching rates. But some of these will include temporary bonuses that, when they end, can see the deposit interest rate fall, in today's terms, from 2.5 to 0.5 per cent.
Should people fix now? "We are seeing people looking for one and two-year products," says Slade. "Four and five-year products are not so popular." She broadly agrees with this approach. There has been much demand for inflation-linked products but, as The Independent went to press, only the Birmingham Midshires and the Yorkshire building society, were in the market.
Slade suggests that savers keep shopping around, go online where many of the best deals are and remember that building societies have tended to offer better rates than banks. She mentions Nationwide, Coventry Building Society and National Savings & Investments as institutions whose offers are often worth looking at. National Savings, for instance, does not lead the best-buy tables but its products tend to be clear, while products elsewhere are getting more complicated.
There is "no nailed-in certainty" that a rise in annuity rates will follow any rise in the base rate, says Laith Khalaf, of adviser Hargreaves Lansdown. "There are pressures that are pushing the other way." So holding off taking an annuity could be risky for this reason. The three principle downward factors are: the possibility of the European Court of Justice imposing unisex annuity rates from 1 March (with a decline in rates for men thereafter, and not much of an increase for women); tougher regulatory "Solvency II" rules from 2013; and lengthening life expectancy.
The best rates available now, according to Hargreaves Lansdown, would result in an annual annuity of £6,500 for a 65-year old man who had a £100,000 fund, and a annual annuity of £6,200 for a 65-year old woman. These rates are nearly 5 per cent higher than six months ago, as rates fluctuate all the time. Khalaf expects that more people, men in particular, will start using the main alternative to annuities, drawdown products. "We may see more men mixing and matching," he says. Drawdowns let people keep their money invested in capital markets while taking some income.
'We're living in limbo'
Few people follow news on base rates more closely than Hertfordshire-based Phil Caplin. The 34-year old marketing specialist and new father is on a Nationwide tracker which offers him 2 per cent above the base rate. "It puts me in the biggest limbo possible," he says. While he and his wife can afford the payments now, he wants to move on to a different deal before rates rise significantly.
A possible deal is a three-year fix from Nationwide, pegged at 3.69 per cent for existing customers. But Mr Caplin thinks he might fall outside the loan-to-value condition that requires him to have a 30 per cent equity share in the house. Looking for a good fix is just one part of the Caplins' strategy. The couple are saving as hard as they can, "waiting for the day that I switch my mortgage and have some savings to pay off a lump sum".
In the meantime, Mr Caplin follows all statements from Mervyn King and the Bank of England's Monetary Policy Committee. Like the Governor of the Bank of England himself, Mr Caplin is reluctant to make a firm prediction. "We just don't know, do we?"
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