Keeping interested

A couple worried about their finances.
A couple worried about their finances.

Speculation about interest rate rises has been in the headlines a lot lately, although it appears that many homeowners are burying their heads in the sand about the potential impact this will have on their borrowing costs.

Research from the Money Advice Service (MAS) has found that more than half of mortgage holders have not considered how they will cope with a rise, and 8% are even unaware that rate rises are on the horizon, despite many forecasters believing this will start to happen in 2015.

Yet when forced to think about it, almost one in five (19%) of the 3,000 UK mortgage holders surveyed admit they will “really struggle” to cover any increase to their monthly payments. More than two-thirds (69%) of homeowners said their finances were already stretched when they took out their mortgage (increasing to over three-quarters (77%) of under-35s).

Rising interest rates will be a completely new experience for many people. According to industry estimates, around one million homeowners have never experienced an interest rate increase, having climbed onto the property ladder after the base rate fell to its rock bottom level of 0.5% in 2009.

So what impact will interest rate rises have on your mortgage payments?

This depends on what type of mortgage you have. Many people have been opting for longer-term fixed rate deals recently in order to give themselves some certainty over their mortgage payments. But even for these people, their deal will come to an end sooner or later.

Around nine in 10 new mortgages being taken out by first-time buyers and existing homeowners are fixed-rate products, which cushion the borrower from any immediate impact of the base rate rising. Meanwhile, around one in 20 new mortgages are trackers, which are directly linked to the base rate. Lenders also offer standard variable rate (SVR) mortgages, which is a rate that they set themselves.

It’s also worth bearing in mind that rates are expected to increase by a series of small “baby steps”, so people will find it easier to acclimatise to the cost of borrowing increasing.

Reassuringly, research by the Council of Mortgage Lenders (CML) has found that, for most people, the widely expected scenario of gradual rate increases is likely to be manageable. So while the MAS’s research found that nearly half of mortgage holders would find it hard to meet a £150-a-month increase in their payments, this level of rise equates to a 2% point increase (to the average mortgage), something unlikely to happen until around 2018 - by which time earnings are also expected to have increased. In the short term, a 0.25% increase would add only around £16 a month to an average mortgage of £120,000.

Of course, that doesn’t mean you don’t have to plan ahead...

So how can you prepare?

The first step you might want to take is to check back through your existing deal to make sure you know exactly what rate you’re paying, whether it’s a fixed or variable deal and when it’s due to come to an end.

Some experts suggest that people should consider using any spare cash they have to pay extra chunks off their mortgage so that the amount left outstanding will be smaller when borrowing costs start to increase. People might also want to look at other areas of spending to see if there are areas where they can cut down.

Now may be a particularly good time to see what other mortgage deals are out there. A mortgage price war has broken out in recent weeks, with many lenders slashing their rates. And a recent survey of lenders by the Bank of England found that this strong competition is likely to continue over the next few months as lenders look to meet their end-of-year targets.

The MAS, which was set up by Government to offer free and impartial money tips, has also placed a new mortgage calculator on its website to help homeowners see exactly how they’d be affected by rising interest rates. This can be found at moneyadviceservice.org.uk/interest-rates-rise.