Your home is your castle. It may not be a mediaeval castle under attack from the Normans, the Dutch, or the French, but today it’s potentially under attack from interest rates and recession.
Interest rates have not been as high as they are now since way back in 2007. However, prior to July 2007, when interest rates were 5.75%, they hadn’t ever been lower than 3.50%.
Surprising statistic (especially for anyone under 40!); The average Bank of England base rate since 1975 is 9.05%.
What does that mean for today? We’ve been here before, right?
Well, the reality is that house price inflation has risen much faster than earnings. This means that now that interest rates are rising, many people are much more ‘leveraged’ than they’ve ever been in the past. In other words, people need to borrow more to buy the same home.
|Decade||Average UK Salary (£)||% increase in Salary||Average UK Property Price (£)||UK Property vs UK Salaries|
What should you do if you have a mortgage deal that is ending soon? What if you can afford to pay off your mortgage, or a chunk of it? Should you?
Nothing here should be construed as personal advice; everyone’s situation is different. You can only make decisions based on the information you have at the time. It can also be best to focus on what you can control. Let’s face it, you can’t control the Bank of England’s interest rate policy. But you can control how much you’re affected by or exposed to rising interest rates.
Things you can control:
- Having an emergency fund remains a sensible strategy. If you use every spare penny of cash to put towards your mortgage, then what happens if work slows down, you’re made redundant, or you receive an unexpected bill (you need to replace a car, the roof needs work, the boiler packs in, or the washing machine leaks).
You don’t want to be in a position where you need to take out new debt, which may be more expensive than your mortgage rate.
- Paying off expensive debt—that debt may now be your mortgage.
- Covering short-term liabilities and goals with cash – If you know you have a liability to cover in less than 5 years’ time, you should consider holding the money for that liability as cash. For example, if you know you would like to pay off your mortgage at the end of the term in 12-24 months or make a significant contribution, you should consider holding that money on cash deposit so that you know you can meet that commitment when the time comes. Investing in the markets is for your long-term goals, and you should continually ask yourself if you still have at least a five-year investment timeframe (longer is better).
For the past 15 years, interest rates have been very low—almost non-existent. You could have been reasonably certain that if you invested rather than paid off your mortgage, you would be rewarded for that decision. Long-term average investment returns of 7% (before tax or fees) easily covered the 1%-3% interest on a mortgage.
Today, long-term average returns could still be around 7% moving forward, maybe less depending on the outlook for global growth, but mortgage interest rates are now 5%-6% and that’s with a base rate of 5%. The base rate is projected to be 6% by the end of the year, falling slowly (perhaps) over the next 5 years to 3.7%.
Global investment market returns continue to be muted. Over the long term, you should still be rewarded for investing, but previously, when it was a ‘no-brainer’ to not pay off your mortgage, maybe now it is a ‘no-brainer’ to pay it off or pay it down if possible.
Once your mortgage is clear, you will have surplus income to continue to save towards your longer-term goals.
There is an element of crystal ball gazing when trying to predict the future. Economists never seem to get it right. The Bank of England’s economists said that inflation could peak at 13% in 2022. (It was 10.5% in December 2022).
They also didn’t foresee it being so sticky and taking so long to fall, particularly core inflation (which strips out the more volatile food and energy prices), which continues to rise.
Recession, although it looks more likely now that interest rates continue to rise, didn’t materialise during the last three months of 2022 and continue for five quarters as predicted.
If you had mentioned to an economist in the mid-1980s that in 25 years’ time, the base rate would be below 0.25%, they probably wouldn’t have believed you, unable to foresee what event could cause such a thing to happen (the Global Financial Crisis of 2007/9).
Will rates go this low again? – Perhaps. Will they reach double figures again? Perhaps?
Stick to the core financial principles, and you can’t go too wrong.
- Have a decent ‘rainy day’ fund.
- Have a good handle on your income and expenditure.
- Make sure you have all the protection you can for you and your family (including wills, powers of attorney, and up to date pension nominations).
- Pay down expensive debt where possible.
- Make overpayments on your mortgage if they are affordable and possible without incurring fees.
- Make sure you are enrolled in your company’s pension scheme and contributing sufficiently to meet your goals and make the best use of any employer matching available.
- Invest any surplus income for the long term.
You may need to do a bit of a balancing act between the final three points, which will be down to your personal circumstances.
At this point, it could be a good time to call on the help of your Financial Planner to chat through the pros and cons of the different options available to you.
Associate | Chartered Financial Planner
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