What happens if the Interest rate increases?

Dynamax

I'm about to buy a house. The base rate at the moment is at Zero, the lowest it can be. In the future when this starts climbing my monthly payment will increase. But what will a rise in Interest rates do for house prices? I'm too young to recall what happened when the interest rates were at 12% back in the 80's, can anyone shed some light on their predictions.

Is it wise to purchase a property now? Or will property prices slump even more if the interest rate increases?

Do you think the base rate will increase at a dramatic rate?

jee

You mean 0.5%?
The economy is pretty bad so most people are not expecting a change for 2-3 years.

GAH

I wish, like many, that I had a crystal ball to predict the future.

The base rate is actually at 0.5%, and many predicted a rise at the end of last year. Now it is thought that we will only see a slight rise in 2013.

When rates actually shot up to 15% all those years ago, it happened over an extremely quick period of time.

I don't forsee that interest rates will rise dramatically, but one thing is for sure, they will eventually rise.

People should always leave affordability in their budget to allow for increases in interest rises.

anyusernamenottaken

The way things are at the moment, a lot of economists are not predicting a rate rise for a good few years. A spike would cripple homeowners and businesses alike.

If you're worried, fix your rate. I think most people (unless they change industries or retrain or lose their jobs) are unlikely to earn less in the future than they do now....hopefully!

princeofpounds

Typically rate rises mean falls in the price of income producing assets like houses.

If someone can afford a mortgage of 1 million at a 1% interest rate, they will be able to afford a mortgage of just 100k at a 10% interest rate. That means there is less borrowed money around to spend on houses that people otherwise couldn't afford.

Or to conceptualise it another way, if you can earn 1% on risk-free government debt then a 3% rental yield (i.e. a price 33 times the rental amount) looks pretty attractive. But if you can earn 10% on government debt you wouldn't bother taking the risk on real estate unless the rental yield was higher (and the price consequently lower).

However, the relationship is not simple or linear, and there is as much sentiment as there is science. For example, looking at the base rate (or for that matter the variable mortgage rate) is a short term thing. Housing is an asset that produces income (or saves you paying rent) over the long term, and so if short-term rates like those shoot up to 10%, you might be happy to deal with that high burden for a short while if you were confident rates were going to fall much lower before too long. So that's one reason why rates at 15% for a short period of time did not cause house price collapse to the degree that would be expected if you were to be paying 15% for ever. Although it wasn't good for house prices all the same!

I always think a good way of sense-checking affordability vs interest rates is to look at the cost of long-term (i.e. 10yr) fixed mortgages. They are priced in such a way that, simply speaking, you should end up paying the same amount over the life of the mortgage as you would with a variable, otherwise people would never lend fixed (and vice-versa). So they incorporate market expectations of future interest rates.

Market expectations are frequently wrong, but they are about as good as you can get unless you are Mervyn King who actually makes the decisions.

Note that variable rates of 2% and 10 year rates of 6% does not mean that interest rates are expected to go something like 2-3-4-5-6-6-6-6-6-6. They are an AVERAGE over the period (and not a simple average, but that's a topic for another time). So it implies something more like 2-3-4-5-6-7-8-9-10-10.

Finally, thinking about your asset side (property prices) is only part of the equation. You cannot figure out what happens to your net worth in real (inflation-adjusted) terms without looking at the liability side also. So whilst buying a house at low rates and holding into high rates means that the house price will probably fall, if the low rates were sufficiently advantageous you will make some of that money back by the real value of your mortgage debt decreasing too.

So an interest rate path might look a bit scary, but realise that each year the real value of the original mortgage sum is being inflated aways so you are paying interest on a lower value.

If you google the idea of 'real interest rates' it will help you understand the 'real' cost of money.

So whilst now might not be a great time to buy a house, it might be a great time to get a mortgage (IF you fix before rates rise, or take a bet that rates don't rise for ages and get proved correct).

Personally, I think rates will stay low for several years, then jerk upwards sharply at some unspecified point in the future, probably accompanied by (or caused by) a devaluation of the pound.

FireWyrm

Rates will most definitely rise, they're being held artificially low at the moment to try a boost the economy but the government is starting to realise that we are simply worse off than they thought. Yes, interest went to 18% and beyond back in the 80's but the economic and political situation that caused it isn't the same this time around. I dint have a crystal ball, but I would bet a slow and steady 0.5% rise for the next several years probably plateauing around the 5.5% mark eventually. So, the question is, can you afford the house you are looking at when repayments are at least 6%. If you can, good for you. It probably won't get much worse than that unless some inconsiderate cuss starts another war. If you can't, don't buy the house. You'll lose it for sure even if you don't get a sudden adversity like losing your job first.

Finally, and I cannot stress this enough...get insurance on the mortgage and pray you never need it. I know life insurance isn't a legal requirement any more, frankly, I think that's barking, but it is what it is. Plan to add about £100 a month in either life, accidental or payment protection insurance. Buy the best of all three you can afford and you will have as much of a cast iron umbrella as anyone has.

ruggedtoast

As well as life insurance, I have payment protection insurance but I dont have a lot of faith in it, it would cover the mortgage for up to a year if I lose my job, I'm not at all clear how that would effect benefits.

I am considering swapping it over to the illness insurance which costs about the same but covers you forever if you can't work. Unfortunately I can't quite afford all three!

As far as the OP's question, if interest rates go up then your mortgage goes up, unless you have a fixed rate loan. A fixed rate loan is a good idea if you are worried about this.

FireWyrm

I believe that the PPI on a mortgage doesn't count against benefits since JSA is for a different purpose and insurance is just that, insurance. Statistically, you're much more likely to lose your job and need the PPI than you are to contract one of a very narrow set of critical illnesses, but it's really a judgement call. Unfortunately, we're not all politicians and so cannot have our cake and eat it, but of the two, I would have PPI over CI any day. If you're worried take out a separate CI which sometime works out cheaper than bundled into a single policy. Shop around...it rather depends how old you are, but CI for a healthy non-smoking young adult was around £25 a month....which is what(?) a night out at the pub once a month?

skinnyman9000

These various forms of insurance are something I'm going over at the minute. My mortgage broker (who is also an insurance broker) is adament I need life insurance, critical illness insurance, and income protection insurance (or something like that, cant remember off the top of my head).

I'm not entirely convinced I need all these. I believe my job is extremely secure, and it's highly unlikely I would lose it, and as for my health, I'm a 25yr old non smoker, hmmmm.

Back to the OP's question. If you have a tracker/variable the interest rate will inevitably rise with the base rate, how long the base rate will remain at it's current level is unknown, but I'd like to think at least another 18-24months is likely.

poppysarah

There are many people who can't afford the mortgages now even with interest rates at an all time low.

Indicative that interest rates are not the only fruit.

princeofpounds

I'm not entirely convinced I need all these. I believe my job is extremely secure, and it's highly unlikely I would lose it, and as for my health, I'm a 25yr old non smoker, hmmmm.

Insurance is not so much about the risk. If you think about it, it's priced for risk. You will get it much more cheaply if your risk of problems is small, and vice versa.

Another way to think about it is impact. If you are single with no dependants and have a source of care (family?) if you fall ill then you do not need such great external support if things go wrong.

But if you have dependants, an/or no method of support in case of crisis, then the impact could be huge. No owned housing for your children. No way of making the mortgage payments.

That's the thing to consider.