How to prepare for a mortgage shock and get a better rate

Mortgage rates are rising at a record pace, putting homeowners at risk of making annual payments hundreds of pounds higher than they have been in recent years.

The two-year average fixed interest rate is now at a nine-year high, and 1.4 percentage points higher than it was in December last year, according to rate-checker Moneyfacts.

But there are steps borrowers can take to avoid spikes.

What is going on with interest rates?

The Bank of England was raising interest rates in an effort to curb rising inflation.

Its core rate has risen from 0.1 percent in November to 1.25 percent today, and is likely to rise again this week. Lenders pass these hikes on to customers.

Take, for example, someone with a £200,000 two-year fixed-rate mortgage that they took out in the summer of 2020.

If they limited themselves to the best deal available at the time, they would pay 1.09 percent interest. But when it comes to re-mortgages, the best equivalent rate would have jumped to 2.79 per cent, which would raise repayment costs by £1,152 a year.

Money’s mortgage comparison calculator powered by brokerage L&C can help you see how high your monthly payments are and show you which loans you can apply for, based on your home value and mortgage size.

What you should do – fix your rate now

If you have a variable rate mortgage, get it fixed now to protect yourself from future rate increases.

Someone with a £200,000 mortgage where interest tracks the base rate could already have seen their payments rise by over £100 a month since interest rates started to rise late last year.

If you’re already on a flat deal, plan ahead so you’ll be ready to secure the best rate when it’s over.

“Most borrowers are on a fixed-rate deal, so until now they’ve been protected from rising interest rates,” says Laura Souter, head of personal finance at investment platform AJ Bell.

“However, the big shock will come when their deal ends and they remortgage – then they will face the full impact of all the recent rate hikes at once.”

Start looking for remortgage deals a few months before your current deal expires. Most mortgage offers are valid for six months, so if your remortgage is due before January 2023, you may be able to strike a new deal at today’s rates.

If rates are lower when it’s time to remortgage, you can ditch the rate you booked earlier and move on to a cheaper deal.

You can also check your credit score to ensure that you qualify for the best possible mortgage rate.

Do this early and have time to improve if necessary, for example by adding yourself to the electoral roll or challenging any mistakes.

Consider a green mortgage

Some lenders offer better rates if your home is energy efficient. Virgin Money, NatWest and Barclays offer competitive rates if your home has an Excellent Energy Performance rating – A or B.

Green mortgages are growing in popularity — online searches for these products have quadrupled a year, according to mortgage technology company Twenty7Tec.

Although the rates for green mortgages tend to be lower than average, they are not necessarily the cheapest available, so it is still worthwhile to compare rates.

For example, Virgin offers a five-year green mortgage at a fixed rate of 3.49 per cent with a cashback of £300. The best five-year fix on the market is 2.78 per cent from Ulster Bank, part of the Royal Bank of Scotland.

Overpay – then get a cheaper loan

Reducing mortgage debt by overpaying makes a lot of financial sense.

“Borrowers who still enjoy a low mortgage interest rate can overpay now to help their credit erode more quickly and be left with a smaller mortgage when their current deal ends,” says David Hollingworth, associate principal at L&C Mortgages.

Overpayments can help you reduce your loan-to-value ratio — the loan as a percentage of the home’s value — and make loans available at lower rates.

For example, take someone who has a house worth £283,000. If they have a loan of more than 65 per cent, they can take out a five-year fixed rate of 3.22 per cent from NatWest with monthly payments of £925.

But if they overpay so that the loan-to-value ratio is 60 per cent, they can access a lower five-year fixed rate of 3.16 per cent than HSBC’s, with installments of £819 a month. Over the full term, they will save £31,699 in interest payments.

Consider switching deals early

Most fixed and discount rate mortgages contain an early settlement fee, which makes them very expensive to switch before the deal expires.

However, if you are not far from the end of your current position, it may be worth crunching the numbers to see if it is worth getting out early.

If you’re struggling to balance the numbers, a broker may be able to help.

‘Tell the broker what deal you’re in now, what your early redemption payments are, and they can see if it still makes the financial sense to switch now before higher rates come out,’ says Angela Kerr, director of the HomeOwners Alliance – an organization that provides practical advice to homebuyers and sellers. .

The number of borrowers paying early payment fees has risen this year – the Yorkshire Building Society, for example, saw an 88 per cent increase in the amount of fees paid by borrowers this year compared to the same period in 2021.

Extend the term of your mortgage

If you are struggling to make monthly payments, extending the term of the mortgage will bring it down.

However, the longer the term, the more interest you will pay. For example, if you have a £200,000 mortgage at 3 per cent, your monthly payments will be £948 over 25 years or £843 over 30 years.

However, you’ll pay an extra £19,000 in interest payments in total if you opt for the long term.

You may also consider converting some or all of the repayment mortgage to an interest-only basis.

For example, if you owe £200,000 on a mortgage to pay it off at an interest rate of three per cent, your monthly payments would be £948.

If you convert it to interest only, the monthly payments will drop to £500. However, you may need a plan for how you will pay off the mortgage in the future.