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Home buyers in UK unlikely to see mortgage costs rise in short term

The Bank of England has indicated that the current 0.5% base rate is likely to be around for some time yet with a rise not looking likely until well into 2016 or even 2017. Rates have now been this low for 80 months.

But there are concerns that home buyers will get too used to low interest rates and this could backfire in the future when interest rates do rise. According to James Jones, head of Consumer Affairs at Experian, buyers need to work out what they can afford, and plan ahead for unforeseen costs that may make repaying debts harder over the years ahead.

A survey of people who had failed to secure a mortgage last year suggests that many are failing to do the basic research needed to get proper control of their finances. Some 13% did not know how much money they have left over at the end of the month and 18% did not know what monthly repayments they could afford.

The research also found that 14% did not have a big enough deposit for the property they wanted and 12% were unable to secure the size of mortgage they needed.

Another piece of research has found that almost three quarters of home owners with interest only mortgages are worried they may not be able to repay their loan. Interest only deals mean borrowers pay the interest on the loan during the life of the mortgage and then must repay the capital when the mortgage term ends.

Just 31% of those interest only borrowers questioned said they have a separate investment policy in place, such as an endowment or an ISA, to pay the capital, according to the research by mortgage broker Ocean Finance.

While 16% said they plan to switch to a repayment mortgage before their current loan ends, 31% said they expect to have to sell their home to settle the outstanding capital. And a fifth of home owners said they don’t have a plan in place to repay the capital.

‘Interest only has become a time bomb because so many people took out the products to cut the cost of their mortgage, with no view of how they would repay the capital element. Borrowers who have an interest only mortgage with no repayment plan need to take action,’ said Gareth Shilton, Ocean’s spokesperson.

‘It’s advisable to seek advice on whether they can overpay on their current interest only deal, switch to a repayment mortgage, or use an ISA or pension to settle the capital payment,’ he added.

Interest only mortgages became popular in the 1990s as a way for consumers to afford homes at a time when property prices were soaring. Lenders often agreed interest only loans without confirming borrowers could repay the capital owing at the end of the mortgage. By the end of 2012 most lenders stopped offering interest only deals after tightening their lending rules.

The research shows that just over a fifth of borrowers with interest only mortgages don’t feel they were given adequate advice about repaying the capital portion of the loan when they took out their mortgage.
‘While there is a place for interest only mortgages, it is a specialised product that suits a small number of borrowers, rather than being the mass market product it became in the 1990s. For example, if you have a large family home that you know you don’t plan to stay in once your children have left home, then interest only could make sense.,’ Shilton explained.

‘Interest only mortgages are now typically only being approved for borrowers who can demonstrate they have a repayment vehicle or pension pot that is forecast to repay the capital element. Usually, borrowers also need to have a significant deposit that gives them a big equity gap,’ he added.

Further research has found that a substantial number of home owners with a mortgage don’t understand what impact just a 0.5% rise in base rate would have on their mortgage. Some 39% said they were in the dark when polled by online estate agent eMoov.

With an average loan to value ratio of 85% those looking to buy at the average UK house price of £209,383 will be borrowing £177,976. On an interest rate of 1.85% this equates to £741 a month, on a 2 year fixed, 25 year mortgage. But should interest rates climb by just 0.5% once the two years is up, the monthly payment of this mortgage will jump by 5.9%.  In London where the average house price now tops £500,000, this increase of 5.9% could equate to more than £1,000 each year.

According to the firm on a loan of £475,000 for a property in London a monthly re-payment will be £2,544 at a rate of 4.14%. But should this increase marginally to 4.64%, the cost of a monthly mortgage payment would again rise by over 5% to £2,678 a month. That’s a potential setback of £1,340 a year for London home owners, once the two year fixed term of their mortgage expires.

‘A jump of £50 to £100 per a month might seem insignificant to most, but for those really borrowed up to the hilt in order to get a foot on the ladder, it could be potentially catastrophic. Despite the comfortable economic climate at present, many UK home owners are counting every penny in order to get by. So an increase of more than a £1,000 a year could soon snowball into a more substantial debt,’ said eMoov chief executive officer Russell Quirk.

‘The reality is that interest rates will rise eventually and when they do, it’s likely to be by more than 0.5% over a short period. So regardless of what loan to value ratio you currently have, your monthly payments will increase by at least 5%,’ he added.