Cut the 50p in the pound income tax rate! (To help the poor souls earning over £150,000 pa.)
Cut the rate of Vat! (to stimulate imports?)

Well we have another angle for George Osborne to consider. Reintroduce Mortgage interest tax relief.

Benefits of Mortgage Interest Tax Relief

• It will help stimulate the housing market.
• When interest rates increase it will help make ownership and repayments just that bit more affordable.
• The squeezed middle class will feel they are getting something from a government they helped to put into power.
• Lenders will be able to assess credit risk a bit more favourably.
• A stimulated housing market will help construction, the economy and ultimately the tax revenues.

Go for it George!

What of Fixed Rate Mortgage Interest.

• The average two year fixed rate mortgage in the UK has fallen to 4.25%

• Five year fixed rate deals are available at below 5%. This is the cheapest rate for almost quarter of a century and longer than most mortgage terms.

• Two or more years of low interest rates, as predicted by the Bank of England, also make standard variable rate deals look attractive. Beware they do not suit everyone, there is still no one size fits all.

• Product fees have yet to be brought under suspicion of miss selling but the day may come. Meanwhile take care with fees and costs if you are thinking of ‘porting’ your mortgage to a fixed rate deal. The total cost is the crucial issue not the percentage rate.

• Felixibility comes at a price and there is an interesting 10 year fixed rate deal from Skipton Building Society at 5.85% with no fee that would suit many who are less concerned about flexibility.

• The size of deposit still attracts a differential interest rate. Yorkshire Building Society charge  4.64% with a 15% deposit but only 3.69% with a 25% and above deposit.

Comment

• Housing market issues of price, loan interest and market activity are still controlled and constrained by the financial turmoil at the powerful banking and financial organisations.
• The damaged state of the western world economies is not going to resolve in the short term. When it is bad it is very bad!
• Mortgagees should keep an eye on the best deal for their own situation. If in doubt sit it out.
• Read Is it Time to Fix Your Interest Rate?

Higher interest rates increase the cost of mortgage repayments making it less attractive to buy houses.

Lower interest rates, with adequate supply of loan funds will make it attractive to buy houses.

In the UK many homeowners have a variable mortgage. This means that the cost of their mortgage is dependent on changes in the Bank of England repo rate (better known as the base rate)

If interest rates increase the following occurs.

• Mortgage interest payments increase, reducing disposable income of consumers
• Demand for houses falls, possibly causing lower house prices.
• Higher interest rates also make it more attractive to save rather than spend money.
• Higher interest rates also increase the value of the exchange rate, though this has little impact on the housing market.

Time Lag of Interest Rates.

When the Bank of England increases interest  rates it might take a long time before it has an effect on reducing demand. This is because people don’t respond immediately to changes in interest rates. Firstly a significant % of people have a fixed rate mortgage and therefore, they will be insulated from changes in the interest rates for the duration of their fixed rate term. However, when their term expires they will have to negotiate a new deal. If rates have increased alot they will experience a significant impact on the cost of their mortgages.

Depends on Economic Situation.

The effect of interest rates may also depend on the situation of the economy. If the economy is in a recession, then any increase in interest rates would have much more effect than when the economy is doing well and people have a lot of confidence.

Base Rates and Bank Rates.

When the Bank of England change interest rates, commercial banks are not forced to change their rates. Sometimes the Bank of England may cut rates, but commercial banks may decide to keep theirs unchanged and just make a bigger profit margin.

International Events

The 2011 Euro zone crisis will push up interest rates. The downgrading of USA from a triple AAA+ rating means the US will have to pay more to borrow on treasury bonds. This will push up interest rates generally and on housing finance specifically.

Low interest rates in the UK since the housing market crash has not protected the Housing Market. The drop in values may have been significantly worse if interest rates had been higher. More defaults, repossessions and more stock on the market without funding.

Updated Aug 2011 from April 2008

Traditional Mortgage Interest

• My main mortgage was repaid during an era when there was little or no choice in the way repayments were calculated. Most mortgages had variable rates and there was no confusing choice and no extra charges every few years.
• Endowment mortgages had to pay the interest at the rate ruling and keep building a fund to repay all the capital at the end of the mortgage period but that was the main alternative option.
• Interest rates did vary and increases were painful but if I could afford to maintain payments when rates fell it quickly reduced the amount outstanding and cut the mortgage term (in my case from 25 years to 19).

Current Options

• The last few decades of dramatic increased ‘flexible’ lending packages and deals were not created for the borrower. The products with short term fixed rates or variable rates with revue options were designed to boost (post privatisation) profits.
• Your options are also in the thrall of the profit orientated financial institutions who still have a risk averse culture following the last few years trauma.
• The economy is the other driving factor on the cost of your loan. Inflation has risen but wage inflation has generally lagged behind. Increased interest rates may help moderate inflation but will slow the already sluggish economic recovery. Current views are that rates and increases will not leap ahead due to the fragile economy.
• Will rates increase? The answer is yes at some point and to some level but how far and how soon is speculative.
• Fixed rate deals seem cheaper now than a few months ago but that may be down to supply and demand and the need to ‘churn’ deals to get the arrangement charges.

Comment

• Make haste slowly. You are in it for the long term and want to get a mortgage free property as soon and as economically as possible without taking risks.
• Look at your options quarterly but if you decide or are forced to make a choice consider opting for the longest deal you can get.
• Look a financial gift horse in the mouth. By that I mean consider all the costs, charges, options and other factors as well as the headline interest rate.
• Where you can, pay down your mortgage for long and short term peace of mind.
• Beware of macro economic events that can disturb the markets. Down grading UK credit rating, USA protectionism, Euro zone problems, Middle & Far East crises even the  volcanic ash clouds can cause turmoil.

To avoid ending on a low note remember ‘Just as you were getting used to yesterday along comes today- may you live in interesting times’

It may not be the time to fix your interest rate but it could be the time to check your mortgage insurance.

Problems for Lenders

• The European Union are preparing to mandate another series of stress test on banks and lenders.
• With the exposure to Japan, pressure from the Yen and the lingering prime mortgage hangover will the British and European banks pass these tests.
• Are lenders margins and balance sheets being adequately rebuilt  to  fund  new debt and mortgage borrowing.
• Rates are below the natural and sustainable levels and will rise.
• Can the banks withstand a significant fall in property values that may follow a jump in interest rates.
• Are savers content to remain on perversely low levels of return.
• Lord Turners report on the FSA warns ‘there is no silver bullet’ on market reform we will have to adapt to developments.

Problems for Borrowers

• Cheap floating, tracker or variable interest rates is good so long as it lasts.
• Any saving on cost should be usefully redeployed, not squandered.
• High loan to value debt seems affordable but when interest rates rise, as they surely must, the debt burden for some families will be too much.
• Rate rises will depress the value of houses as repossessions increase. This could be as bad as a further 20% fall in some sectors of the market.
• The squeeze is on for middle income families and the government policy and the next budget may add further woes.
• Lenders try to make money in ways other than interest rates eg; arrangement fees, exit penalties, short discount periods, reversion rates,  valuation fees etc.

The old sore ‘ If it ain’t broke don’t fix it’ may need replacing with ‘It is broke and we can’t fix it’ or at least it will take four years or more to get back to the same position as last year.

The usual advice for borrowers who anticipate an increase in interest rates is to opt for a fixed rate deal. The plus side is you fix the amount you are paying each month.There is a blanket of security but only for the length of the fix.

The downside is that many lenders are using this to increase their margins and have already factored in some increase. Additionally short fixes need renegotiaiting and there are usually transaction fees to pay. Rates may also not be favourable in 3 -5 years or when the fixed deal terminates. 5 year fixed deals now may be very expensive.

Low cost tracker mortgages have conversely become cheaper recently and are at a relative all time low. Life time trackers can be found at HSBC for2.29% (bank rate plus 1.79%) with 40% equity, low fees and no redemption penalties. A 5 year fixed deal with smaller equitymay cost over 5.5% .

The question is whether trackers will be better over the longer term. Interest rates would have to increase considerably to narrow the gap and compensate for the current over payment on a 5 year fixed. It should pay to hold your nerve and stay on a floating rate. However interest rates are fickle and you should ensure you can afford the repayments should rates mushroom.

Tips and Ideas.

• Think of your mortgage over the longer term, short term gains may cost more in the long run. We particularly do not like having to pay several steep ‘Fees’ to renegotiate our basic deal.

• Remember the market reacts in anticipation of events rather than after them so increases are priced in early.

• Overpay your mortgage if you can afford too, rates may never be this cheap again and you may have a one off opportunity.

• Getting to 40% equity is worth the effort reflected in lower interest rates.

• Keep checking deals from different suppliers that may include hybrid deals. Some with a  ‘Drop and Lock’ facility offer variable for a period moving to fixed rate later but they are at a price.

• Make sure you are in a deal without penalties so you can move if you are taking the wait and see route.

‘Even estate agents, those eternal optimists for whom anything larger than a broom cupboard is ‘spacious’ and any neighbourhood without a drug dealer on every street corner is ‘desirable’ are predicting that prices will continue to fall in 2011. This may not matter that much in itself (unless the house in question itself is yours of course) but a nation of homeowners who feel they are getting poorer is yet another brake on spending.’

read the full story by Andrew Saunders deputy editor management today 23 December 2010

MPC member Paul Fisher has hinted strongly at big rate rises to come, even as mortgage lending hits a 20 month low.’
He is the Market Chief at the Bank of England and believes that interest rates, at some point, will go up again and that they will head to a normalised position of around 5pc.
Read further information on mortgage guide UK rate predictions.

Historical Base Rates

The sharp decline in interest rates.

Interest rates peaked in 1990 when the UK was fighting to stay in the ERM and keep the value of the Pound fixed. The combination of high interest rates and strong pound reduced the inflation, created by the Lawson boom, but, also caused a deep recession.

After the UK left the ERM, interest rates fell sharply allowing the UK to grow.

During the 1990s and early 00s, base interest rates remained remarkably stable – between 4 and 6%. This reflected the long period of low inflationary growth. However, this stability hid behind a mask of unsustainable house price rises and subprime mortgage lending.

In 2007, the house price bubble burst, and a modest recession became very deep in the autumn of 2008. This sharp downturn, led to a quick cut in interest rates as the MPC realised the extent of the economic downturn.

Read Fixed Rate Mortgages Revisited Aug 2011

On the one hand the slowdown in the Housing market could lead to a wider economic slow and possible recession. On the over hand inflationary pressures are actually rising, due to a variety of cost push factors. If the bank responded by cutting interest rates, they would risk increasing inflation above the governments target of 1 -3%. This could turn the temporary cost push factors into persistant and continuous inflation; it would raise inflationary expectations and lead to higher interest rates in the long term.

However, with house prices falling and interbank lending increasing, there is also pressure for the Bank to cut rates. It looks likely that the housing downturn will get worse before it improves. If house prices were to fall by 20-25% then it would significantly affect consumer confidence and consumer spending. The UK economy has relied quite heavily on consumer spending in the past. A fall of this magnitude would definitely slow the economy.

It may come down to the question of whether they think their highest priority should be low inflation or low unemployment.

However, I think the problems in the housing market and global economy are sufficiently problematic to warrant a cut in rates. I would predict a fall of 0.5% in the next 6 months.