Monday, 31 January 2011

Interest rates: could you soon face financial ruin?

Homeowners who bought at rock-bottom interest rates are 'on the edge of an abyss' and could have problems paying their mortgage when rates finally rise
Homeowners who took out a mortgage during the past two years and know nothing other than rock-bottom interest rates could face financial ruin when the Bank of England finally raises the cost of mortgages.
The rate-spoilt generation are "standing on the edge of an absolute abyss", according to Heather Keats of the Community Money Advice debt charity. She said: "This is going to be the most enormous problem for us, because people are simply burying their heads in the sand at the moment."
Some economists believe a rise in base rate, previously not expected until the end of 2011, could be closer following spiraling inflation and last week's news that two of the nine Monetary Policy Committee members voted for a rise in January.
The outlook is particularly grim because consumers are already feeling the squeeze thanks to a combination of "toxic" factors: the recent VAT increase, rising inflation, imminent public sector redundancies and the knock-on effect in the private sector.
Moreover, wage freezes and overtime bans have led to real wages being eroded to 2005 levels. "One has to go back to the 1920s to find a time when real wages fell over a period of six years," said the Bank of England's Mervyn King last week.
Mortgage borrowers can therefore ill afford to ignore the prospect of interest rate rises. But more than seven million homeowners have not reviewed their mortgage since the base rate first fell to 0.5% in March 2009, according to research by advice website With the base rate remaining at 0.5% for a record 22 months, homeowners have been lulled into a false sense of security and have failed to review their mortgage rates, the website said.
One in 10 homeowners said they have never reviewed their mortgage at all, and a small but significant proportion of those who have (4%) said they had failed to take any action because they did not understand what effect a change in base rate would have on them.
The real nightmare is for those who took out their mortgage some time ago and borrowed at 75% or more loan-to-value (LTV). For these people it will be more difficult to secure a fixed rate now and the higher the mortgage percentage, the harder it will be to find a decent rate. They might find there is little they can do. But make no mistake, a rise in interest rates will impact hugely on a household's finances.
A rate rise of one percentage point would add £76.38 to the £648 monthly cost of a 25-year £150,000 repayment tracker mortgage with a rate of 2.17% (the average of the three current best buys), according to A two percentage point rise would add £158 per month and if the mortgage rate rose by three percentage points to 5.17%, borrowers would face an extra £244 each month.
Even a 0.5% or a 1% rise will lead to her charity being flooded with people who are desperate. "It will affect everyone all across middle-income Britain, as they are often the ones who had previously used different types of credit, such as loans and credit cards, because they knew how to. Credit tightening now means they will have few other options.
The problem of rising mortgage rates applied not just to first-time buyers, but anyone who has stretched themselves financially, regardless of how long they have had their mortgage.
"The banks' attitudes are different now after they all got their fingers burned by the credit crunch. When a borrower gets into trouble, instead of looking at different repayment structures or helping customers, they will want to dive in and get their assets back. It could have a snowball effect on household debt."
Keats said her charity usually starts dealing with consumers' problems around eight months after a rate rise occurs, when everything else they have done to meet their housing costs has failed. Even if someone's home is repossessed, that's not always the end of it,A bank can still pursue former homeowners for any shortfall they believe they are owed for up to 12 years. When interest rates hit 15% in 1990, we were still dealing with related financial problems in 2002. The fall-out is incredible."
Una Farrell of the Consumer Credit Counselling Service said the charity's clients are currently making an average monthly mortgage payment of £564.60, meaning a two percentage point increase in rates would see client's mortgage costs rise by £308. "That is quite an increase when the average CCCS client only has a budget surplus of £43," she said.
Debt counsellors say that when borrowers are put under financial pressure a debt spiral occurs, where they try to juggle their debts and make a choice as to which repayments or bills they should pay first.
The problem is that when consumers panic and there are people knocking on the door for their money, they can make the wrong choices.
Whether you have done a budgeting exercise before or not, do one today go through your expenses and see if there is anything that can be stopped for the time being and, for the essentials, can you find a cheaper provider? There are so many resources available online these days it is almost impossible not to be able to save money on your bills, but no one else will do that for you – you have to do it yourself.
Clearly, the best advice is to take action now, because the headache of interest rate rises is undoubtedly on its way. There is nothing you can do to stop it, so prepare yourself.

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