What would happen to the mortgages if the base rate was 3%, 5%, or 7%?

Earlier this month, the Bank of England raised its base rate by 0.5 percent – the single largest increase in 27 years.

It is the latest in a series of highs. The base rate rose from 0.1 percent in December to 1.75 percent now, and the Bank’s Monetary Policy Committee has signaled it is ready to move forward.

In its latest report, the bank predicted that inflation, and more specifically the consumer price index, would rise to 13.3 percent by the end of the year.

Mortgage rates have increased due to a higher base rate, amidst a backdrop of rising energy bills and food prices.

Since January 2022, interest on a two-year fixed mortgage has jumped from 1.3 per cent to 3.46 per cent, according to an analysis from L&C Mortgages, increasing average monthly payments by around £159.

Understandably, borrowers are keen to understand how far they might go.

Part of the answer may lie in the ongoing Tory leadership campaign being played out in the background.

As the two candidates, former chancellor Rishi Sunak and current foreign secretary Liz Truss, compete to win membership of the Conservative Party, the impact of their economic policies on the people’s finances has been a topic of debate among experts.

Some say Truss’s proposed tax cuts would lead to a base rate of as much as 7 percent.

While a high prime rate may seem out of the question for younger borrowers, there is historical precedent. UK interest rates averaged 7.15 per cent between 1971 and 2022, reaching an all-time high of 17 per cent in November 1979.

Taking advantage of this, Sunak’s campaign created an online tool to calculate how much the 5 percent principal would increase interest on individual mortgages.

What will happen to the base rate under Sunak’s premiership is not clear.

Take a look at the impact that higher interest rates in the future could have on mortgages and the real estate market.

situation today

Over the past few months, the market has been quick to respond to a hike in the prime rate, with mortgage rates rising even before the central bank’s announcements.

This is a problem for homeowners, says L&C mortgage broker David Hollingsworth. Borrowers are used to lower rates and those nearing the end of a fixed deal will experience a payment shock that will cause “some pain”.

Anyone on a tracker mortgage will automatically see their rate increase by the same amount as the prime rate, while those with standard variable rates are also likely to see costs go up.

However, 76 percent of borrowers are fixed-rate—so the pain of high rates will pass to borrowers very slowly as their deals expire and they remortgage.

The effect of rising to 3 per cent

The average flat rate for two or five years is currently around 3.5 percent. Assuming that higher interest rates are broadly reflected in fixed mortgages, that would mean an average of 4.75 percent if the base level rises to 3 percent.

Looking at the SVRs, the current benchmark rate at Lloyds, let’s take for example, sits at 5.24 per cent after trenching a recent 0.50 per cent increase.

If the increase to 3 percent is directly reflected in the SVR, that would mean a rate of 6.49 percent. However, Hollingsworth says this is a very simplistic view.

“Even increases in SVR are more measurable if the base rate rises significantly,” he says.

“When the base rate averaged 5 percent in 2007, SVRs weren’t that high and were often 2 percent higher than the base rate.”

A £150,000 mortgage at 5.24 per cent over 25 years would cost £897.99 per month. At 6.49 per cent, the price rises to £1,011.87 – an extra £112.88 per month.

A rise in the principal rate, even 3 percent, would have a significant impact on the housing market according to Raymond Bolger, chief technical director of mortgages at Realtor John Charcole.

“Based on the current market expectation that the bank rate will peak at 2.5-3 percent, I think house prices will decline modestly next year, around 5 percent,” he says.

But if the bank rate goes above 3 percent, I would expect an even bigger drop. This could indicate that inflation will continue to rise for longer than currently expected, with all the impact that it will have on cost-of-living pressures.

The impact rate rises to 5% and more

At 5 percent, mortgage experts say the market will start to see significant pressure.

By L&C’s calculations, a rise in the base rate to that level would see SVR rates rise to 8.49 per cent, or £1,206.83 per month on a £150,000 mortgage – an increase of £308.84 from today’s levels.

“An increase to a bank rate of 5 percent will make life very difficult for many borrowers when their fixed rates expire,” Bolger says.

“Many won’t pass the remortgage company’s affordability test, but they’ll still be able to get a new deal from their lender by moving the product.”

At 5 per cent, the monthly payments on the £250,000 30-year repayment mortgage would be £1,462.

Bolger says the impact on the market of a 7 percent base rate will be profound, and that’s before the rising cost of food and bills are factored in.

Homes that are still affordable for many people at current mortgage rates of 3 percent to 4 percent will become unaffordable and this will lead to a mix of lower buyers and forced sellers who can’t afford the new higher rates when their fixed price ends. In a significant drop in housing prices.

The last major price drop was between the fall of 2007 and the spring of 2009, when prices fell 20 percent. Bolger says that if bank interest rates rise to 7 per cent, the UK could see a similar drop in rates of up to 25 per cent.

How about a stress test of affordability?

In theory, most people with a mortgage should be able to afford a 7 percent mortgage rate because they would have been stress tested at about that level when they took out the mortgage.

Last month, the Bank of England called for a mandatory mortgage affordability test – but most experts expect lenders to continue testing borrowers’ finances to similar levels.

However, broker Oli Pearce of Guild Mortgage Services says the calculation would not have taken into account the huge inflation fears hitting households right now.

“Although people can technically afford the level of borrowing, they may not actually be able to afford the monthly payments,” he says.

Pierce also mentions the impact rate increases will have on the rental market. He says that higher interest rates increase costs for private landlords, and this will be reflected in rents for tenants.

“The alternative is for landlords to start selling their inventory and reduce the availability of rental properties even further,” he adds.

“Owners are already having to bear the brunt of improving the energy efficiency of a property [to meet proposed regulations]And changes in taxes and mortgage costs that are now likely to rise, so renters are more likely to see rent payments increase if they rise significantly.