The latest snapshot of the UK’s economic growth has fuelled a heated debate about when the Bank of England (BoE) will raise UK interest rates since the financial markets fell off a cliff and we witnessed virtually every investor in the market either gunned down or go white & pasty with fear and panic.
The latest snapshot of the UK’s economic growth has fuelled a heated debate about when the Bank of England (BoE) will raise UK interest rates since the financial markets fell off a cliff and we witnessed virtually every investor in the market either gunned down or go white & pasty with fear and panic.
You see for the past six years the bank rate has been held at 0.5% with early predictions seeing a first rise around March or April 2016 especially after the GDP growth bounced back in Q2 after a sluggish New Year slowdown and inflation barely registering a positive number. Todays inflation report strengthens this view further.
Majority Decisions…
The monetary policy committee (MPC) has almost been voting unanimously to keep rates on hold due to low inflation, although one committee member broke ranks calling for a rise. Signs of a strengthening economy, UK unemployment falling (now at 5.6%) and pay rises running at 2.8% demonstrate the need for higher rates.
However even after the first rate rise the market pricing will be a much slower increase than previous cycles. We should expect a rate of 1pc by the end of next year, 1.5pc by the end of 2017 and 2.5% in 2025. It’s not surprising then why each month both savers and borrowers wait to see whether the rate has gone up or down, because they will affect finances in a major way.
It’s no secret there are winners and losers from interest rate rises
There have been major winners and losers with the current low interest rates. For savers holding on to large amount of cash reserves – this hasn’t been good news. Especially with the fact savings accounts have performed pretty poorly as a result.
On the other hand, borrowers with mortgages have fared much better. If you took out a tracker mortgage – linked to the base rate – then you will have seen the cost of your repayments tumble.
So what do interest rate rises mean for you?
If you’re a saver then any interest rate rise is likely to be good news. When the BoE moves rates upwards you can expect the bank or building society to follow suit. This could see your saving pots grow more quicker or the income you can draw from your savings go up too.
If you have credit card debt, a loan or a mortgage then you’re less likely to be pleased. You see any rate rise will likely mean an increase in your borrowings and as a result, your monthly repayments be hit harder (depending on the conditions of your loan).
However if you have a fixed rate mortgage, you won’t be affected if rates go up during this period, but will when you come to the end of your period and you wish to remortgage.
The likely impact of incremental rate rises may not sound like much but it could be unpleasantly surprising. An increase of 2.5% in the base rate wold mean someone with a £150,000 repayment mortgage would have to fork out an additional £230 per month.
Mortgage holders (especially those on residential loans) would need to increase their income, cut their spending, start making overpayments or refinance their loan to secure a new fixed rate deal before base rate shifts.
But you see, with every problem comes opportunity, and here’s what professional property cashflow investors do to (survive and) thrive in times of interest rate hikes, and what you can do too:
1. ‘Fixed’ mortgages
2. ‘Tracker’ mortgage (based on long term trends)
3. ‘Self-insure’ (hedge)
4. ‘Equalise’ (read on to find out how)
1. Fixed rate mortgages:
depending on the market, you can get 5 and 10 year fixed rate mortgages, which cannot go above a set level in the term of the fixed part of the loan. This is a safe way of protecting against rate rises, and very secure. You know from day one what you’ll be paying. You can work out more precise, less ‘variable’ cashflow figures. Downside protected, and you can sleep easy.
But…
You will overpay for a fixed rate vs. a variable [tracker] rate mortgage. You’re paying extra for the security. The banks want to hedge against future rate rises by charging you more; an insurance policy of sorts. You are also tied in for a longer period so your exit is restricted. But if rates don’t rise, you could have paid significantly more over the term, which could have gone in your pocket
A borrower with a 30% deposit would be paying a 2.3% premium if they took out a five-year fix over a tracker.
Putting an average 2.49% tracker head-to-head with the 4.79% five-year fix shows the fix adding £181 a month to monthly repayments on a £150,000 mortgage.
But is it worth the risk?
2. Tracker or fixed? Increased risk or overpayment:
The smart money is in diversifying your mortgage products so you have spread risk across tracker and fixed rate mortgages. Your hands may be tied by what mortgage products are available, but across a full cycle it is savvy to have a balanced mortgage portfolio of tracker and fixed products and to ‘self-insure.’
3. The ‘self-insure’ strategy:
Compare the current tracker and fixed rate mortgage products, take the tracker and pay the difference in cost each month into a savings account
You are in effect stock-piling cash as your own insurance policy for rate rises, by paying the fixed rate but covering the potential future rise yourself. You win either way, because if rates rise you’re as covered as you would have been with a fixed rate (barring serious disasters), and you get to save, earn on or lend out the cash if the long term tracker ends up less expensive.
4. To ‘Equalise’:
Is to use all 3 strategies in a diversified strategy, across different markets, mitigating any major market change, and ‘pound-cost-average,’ the benefits of all markets.
You can leverage your self insurance money for a compounded 5-8% a year return in a liquid investment, and each subsequent tracker mortgage becomes less risky in isolation.
Think of it as a personal life insurance policy without death at the end.
