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Mortgage risk on?

Mortgage risk on?

How scared should you be about rising mortgage costs? It's the biggest financial risk many homeowners face. Nearly three-quarters of borrowers pay less than 4.5 per cent interest on their home loan – compared with a 30-year average of 8.4 per cent. If rates start to normalise, the economic impact would be profound.

Of course, this seemed a distant prospect until this month. But four lenders have now warned their customers of imminent rate increases. RBS kicked off with a seemingly innocuous announcement that the rate on two niche mortgage products would rise by a quarter of a percentage point. But then Halifax – the nation's largest lender – said it would raise its standard variable rate or SVR (to which mortgages typically default after an initial term) from 3.5 per cent to 3.99 per cent. The move will affect an estimated 850,000 customers, with the average mortgagee having to stump up an extra £16.40 a month.

The largest player in an industry is called the 'market leader' for a reason – smaller rivals tend to follow. Bank of Ireland promptly announced its SVR would rise by an eye-watering 150 basis points to 4.49 per cent by September. And on 9 March Clydesdale and Yorkshire Banks said it would increase its SVR to 4.99 per cent in May, affecting roughly 30,000 mortgagees.

These moves underline how many borrowers are exposed not just to the monetary strategy of the Bank of England, but also to the commercial strategies of lenders. And while the Bank shows no sign of changing stance, it's all too easy to imagine commercial banks acting to protect profit margins.

The big question is whether the latest moves will set a trend. Optimists can take heart that Nationwide and Lloyds cannot get out of commitments to keep their SVRs within 2 percentage points of the Bank rate. And stronger lenders will doubtless seize on their rivals' discomfort to take market share. Santander, ever the opportunist, posted a note on its website that it "has no plans" to change either its SVR or that of Alliance & Leicester.

It's also true that both Halifax and Bank of Ireland had unusually low rates before the latest increases. For this reason, Ray Boulger, a veteran mortgage watcher at brokerage John Charcol, doesn't expect the dreaded 'domino' effect. "It's a good story, but it doesn't stack up – it's a storm in a teacup," he says.

But a more pessimistic reading rests on the example of Clydesdale and Yorkshire Banks, whose rate was already fairly high at 4.59 per cent. David Hollingsworth at mortgage broker London & Country thinks other smaller lenders may use cover from Halifax to restore some of their lost profits.

Moreover, the reasons for the rate increases – rising bank funding costs – are firmly entrenched. Regulators are encouraging banks to fund loans from deposits rather than wholesale markets, and new savers can only be attracted with interest rates of at least 3 per cent. Wholesale funding is also much more expensive than before the credit crunch, and banks are required to hold more reserve capital against their assets. These pressures are unlikely to subside.

Whatever happens to SVRs in the next few months, their long-term course is therefore upwards. Does that matter for your mortgage? It all depends on two factors – whether you're paying the SVR, and how much equity you hold against the mortgage. The share of UK borrowers on SVRs is probably between a third and a half (the rest are on base-rate trackers or fixed-rate deals). Of those, many will have enough equity to move elsewhere if their rate climbs too high; hitherto lenders have tried to manage the bad press from raising rates by waiving the usual transfer fees.

But that still leaves a substantial minority of borrowers with a big headache – among them buy-to-let landlord Sam Collett, whose loan from the Bank of Ireland will cost her an extra £196 per month. She was also a victim of an earlier round of rate increases in 2010, including by Skipton Building Society, which infamously invoked an 'exceptional circumstances' clause to renege on a supposed guarantee to cap its SVR at 3 percentage points above Bank rate. Ms Collett took the matter to the Financial Ombudsman, but it ruled in Skipton's favour on the basis that she could always remortgage elsewhere. But, unable to find cheaper finance, she remains a frustrated Skipton customer on a series of new fixed-rate deals that added tens of thousands of pounds in arrangement fees to her mortgages. "I had a guarantee but they were able to overturn that," she says. "It's terrifying."

This sorry story has two familiar morals. First, the lower your loan-to-value ratio, the better the rates you can access. Second, lifetime trackers can be less risky than fixed-rate mortgages that default on to an SVR rate. The rate will still rise in the end – but at least it is in the hands of public servants rather than deleveraging banks.

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By Stephen Wilmot,
16 March 2012

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Stephen Wilmot

Stephen Wilmot covers property at the Investors Chronicle, including both the listed commercial real estate companies and buy-to-let investments.

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