Entries Tagged 'interest rates' ↓

Mortgages are paid back over a period of 25-50 years. Monthly mortgage repayments depend upon the interest rate charged by the bank building society. Homeowners choose between variable interest rates and fixed interest rate mortgages.

Variable mortgage interest rates.

Most mortgages in the UK have a variable mortgage interest rate. This means that the interest rate on the mortgage depend on the base rate, set by the MPC. If the base rate increases by 0.5% the rate charged on your mortgage will increase by a similar rate.

Therefore, every month, many homeowners anxiously await news from the Bank of England when they decide on the base rate.

How Does Bank of England Set Interest Rates?

The Bank of England is actually not primarily concerned with the housing market and homeowners. The government has given the Bank just one objective - an inflation target of CPI = 2% +/-1 Therefore, the Bank of England will seek to keep inflation within this rate, even if it means hardship for mortgage owners.

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UK interest rates are currently 5.75%. A few months ago, may forecast that interest rates would soon rise to 6% and possibly higher. However, recent events suggest that interest rates may have peaked already, and in the coming months interest rates could fall due to lower inflationary pressure.

Reasons why interest rates are predicted to be lower.

• House Prices Overvalued. An IMF report suggested that house prices in the UK are 40% overvalued. This does not necessarily mean a crash in imminent, but, it does mean there is the prospect for a slowdown and possible fall in house prices in 2008. A fall in house prices would reduce consumer confidence and consumer spending. This would reduce inflationary pressure and enable interest rates to be cut, without inflation going above target. - See why house prices are set to fall.
• Potential of future Credit Crisis. In this blog post, I posted how the Bank of England feels there is still the prospect for a serious financial crisis. This uncertainty could cause a slowdown in the economy and require lower interest rates to deal with it.
• Slowdown in global growth. With recession looming in the US, this could result in slower global growth and therefore, inflation will be lower. However, it is worth noting that the US economy is less significant for affecting global growth than it used to be.

Fixed Rate Mortgage interest rate predictions

At the moment, I feel fixed rate mortgage deals are a little expensive. They are based on interest rates remaining around 5.75%. If interest rates do fall in 2008, there will start to be much better fixed rate deals.

Sub Prime Mortgage rate predictions

Unfortunately, although base rates have stayed the same, the actual cost of sub prime mortgages has increased. This is because there is an increased risk associated with sub-prime mortgages.

Why can banks increase interest rates on mortgage repayments, even though the Bank of England Base rate remains the same?

This is a good question from a reader.

Recently British and American mortgage lenders have been increasing the cost of their mortgages even though the Base interest rate has not changed. This is the explanation:

• The Bank of England (Fed in US) set the Base interest Rate. This is the most important interest rate in the economy. Most banks have to borrow money at this interest rate, therefore, it is very significant in determining other interest rates. If the Bank of England increase interest rates, the main banks will usually respond by increasing their standard mortgage interest rates by the same amount.
• This is what the Fed and Bank of England want. They want to influence the main interest rates in the economy

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The Bank of England, took the unusual step of saying that interest rates were highly unlikely to rise above 6%. They believe there is still inflationary pressure in the economy. For example, in recent weeks the latest economic data has shown:

• Strengthening manufacturing sector, output has been increasing more than expected
• House Prices still Rising. Report by Halifax has actually shown house price inflation rising in recent months.
• Increasing cost of oil, petrol, and other energy sources.

6% would be the highest level since January, 2001

However, others dispute whether interest rates really need to rise.

• Volatility in economy following floods and stock market falls.
• Increasing number of people on fixed rate mortgages having to renegotiate a new fixed rate contract, significantly higher than 2 years ago. After a delayed effect of 2 years,  they will finally face the impact of rising interest rates and have to reduce spending as a result.
• Subdued pay claims. This is an important determinant of underlying inflation.
• Rising energy costs are likely to be quite volatile, they don’t affect the underlying inflation rate.

The Bank admits that for those consumers who have borrowed heavily, rising interest rates are likely to mean financial hardship and an increased number of bankruptcy’s

When giving advice on mortgages it is important to be able to offer advice about the future direction of interest rates. For example, it makes a big difference as to whether a customer should take a fixed or variable mortgage. The future of interest rates depends upon many factors.

In both the UK and US interest rates are set by the Central Bank. The important factor is that their primary target is the control of inflation. The UK has a specific target of keeping CPI inflation between 1 and 3%. In the US, the Federal Reserve have a similar commitment to keeping inflation low. In recent statements made by….. it is clear the control of inflation remains a high priority.

Therefore, the determination of interest rates depends on forecasts for inflation. If inflationary pressures are forecast to rise then it is likely interest rates will be increased to pre-emptively reduce the inflationary pressures. Inflation is dependent on many factors:

1. Economic Growth and the amount of spare capacity. If the economy is growing above the long run trend rate of growth, the economy will experience supply constraints and therefore inflation. In the US, any growth above 3% is likely to cause inflation.

2. The Housing Market. Interest rates are not set to directly effect the housing market. But a fall in house prices, has a big effect on reducing consumer wealth, confidence and therefore spending. Therefore a fall in house prices is likely to reduce inflation and enable lower interest rates. see: will house prices fall?

3. Supply Side factors. Inflation is not just caused by economic growth and demand side factors. It is also caused by cost push factors. For example, rising energy prices will feed through into domestic inflation  and therefore increased the pressure on interest rates.

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The Bank of England, yesterday increased interest rates to their highest level for 5 years. Interest rates now stand at 5.75%, which represents a 1.2% increase since last August.

The Bank cited underlying inflationary pressures in the economy. In particular, they pointed to the pricing power of companies and the growth in borrowing and broad money. Although, CPI is still within the government’s target of 2% +/-1, the more reliable RPI (which includes housing costs) is just below 4%

As interest rates rise, yet again, there was evidence that UK consumers are facing record levels of personal debt. The level of personal debt in the UK now stands at £1.33 trillion. This equates to an average of £54,000 per person. Furthermore this debt is not equally spread out. Levels of debt tend to be much higher amongst the younger generation, who struggle to get on the property ladder.

Therefore, the effect of this is that the increase in interest rates will have a more than proportional effect on young borrowers.

The ratio of house hold debt to personal income has increased from 50% in the 1970s to about 140% now. A significant reason for this is the rise in unsecured loans. Banks are increasingly generous in giving unsecured loans with less credit checks.

• UK Housing Market 
• What determines interest rates in the UK