Turbulence in the mortgage markets and rising costs of fixed rate mortgages have become front page news in recent weeks, as the financial markets pencilled in further increases in bank base rate to address stubbornly high inflation.

For those looking to buy with a mortgage, higher interest rates mean lower budgets and less spending power. We can expect this to act as a drag on house prices and market activity over the next 18 months, although prime markets, which are typically less dependent on mortgage lending should be less affected.. 

But while ambitions to get on or trade up the housing ladder can be scaled back or delayed, those coming to the end of a fixed rate mortgage have no choice but to face up to higher mortgage costs.

The scale of the increase in interest rates

At the time of writing, the cost of a 2-year fixed rate, 75% LTV mortgage via one of the country’s biggest mortgage lenders stands at 5.44%. For those contemplating a 5 year fix, it stands at 4.99%. 

Such costs would have been almost unthinkable when those coming to the end of their current fixed rate last ventured into the mortgage market.  Someone coming to the end of a 2-year or a 5-year fixed rate mortgage, will be saying goodbye to mortgage rates of 1.29% and 1.64% respectively.

Of course, this is not an immediate concern for the whole market, but over the next 18 months we estimate that 1.9m fixed rate deals will come to an end.

To understand what this means for borrowers affected, it is worth looking at a couple of worked examples to see how this varies: 1. the average household who first bought in 2021, and 2. the same household who first bought in 2018.

1. Coming off a 2 year fix; painful but not fatal

In mid-2021 this average first time buyer household had aggregate earnings of £55,000 and purchased a property for £256,000 with a mortgage of £190,000.  A full capital repayment mortgage would have cost them just under £8,400 a year (£700 per month equal to 15.3% of their gross income).

Mortgage repayments made over the past two years mean they would now be looking to refinance £179,000 of mortgage debt. Another two-year fixed rate would now cost them £12,800 a year (£1,065 a month).  That equates to an increase of over £4,400 per annum (+53%) in mortgage costs.

Mitigating factors

On face value that’s not pretty, but there are some mitigating factors. 

Firstly, their mortgage payments as a percentage of income are coming off of a historically low base. In part, this reflects the abnormally low interest rates available when they first bought. It also reflects the strict stress tests they went through when they first took on a mortgage, which prevented them from maxing out on debt.

Secondly, over the past two years, average earnings have risen by 13%.

That means, the same household could now expect their earnings to be over £61,500. So while they will face a sharp increase in mortgage costs that will put a dent in their current household finances, their new mortgage payments would still be less than 21% of their gross income.

2. Coming off a five year fix: Less hurt for those who have been in the game for longer

In recent years we have seen more people move to a five-year fixed rate mortgage.  Indeed, over half of those coming to the end of a fixed rate in the next 18 months, will have fixed for five years or more. 

The first time buyer of five years ago will have started with a smaller mortgage based on a lower house price and made an additional three years of capital repayments. In this example, going from one five-year fix to another will mean their average mortgage costs go from around £7,600 to £8,600 per annum.   While that is still an increase in mortgage costs of over £1,900, the increase in average weekly earnings over the same period will have matched that.

What does this mean?

For many households coming to the end of a fixed rate mortgage will be uncomfortable but, for most, it should not be unmanageable.  

That limits the prospect of direct government support which has been called for in some quarters (especially given it would be contrary to the stated aim of getting inflation under control). Instead, the government has asked banks to work with heavily stretched borrowers to help them manage their finances, through extended mortgage terms and going interest only for a period. For the average first time buyer coming off a two year fix, temporarily going interest only would bring their monthly payment down to £810. That is a 17% increase in their housing costs, broadly in line with average wage growth over the past two years.

Consequently, there is limited risk of the level of forced sales from owner occupiers, that were a strong contributory factor to the significant price falls we saw in the 1990s downturn.  More stock may well come to the market from indebted Buy to Let Landlords, but downward pressure on prices is still more likely to be a function of reduced buying power than a flooding of the market.