SOME time-bombs can be defused. Not this one. At some point – in a year, in two, or perhaps even in five – the cost of borrowing for consumers will climb back to the sorts of levels we were used to 15 years ago. Complacent borrowers addicted to rock-bottom interest rates – and for whom an 8 per cent mortgage is almost inconceivable – will be in for the rudest awakening of their lives. The timings are unclear; the direction of travel isn’t. The Bank of England, which will doubtless keep base rates on hold today, has been desperately trying to keep money cheap, but it only controls very short-term interest rates.
Longer-term rates are determined by powerful market and regulatory forces that are largely independent of the official base rate; and they are already beginning to shoot up. Halifax (part of Lloyds) will increase its standard variable rate from 3.5 to 3.99 per cent on 1 May and the rate on two other products from 3.4 to 3.89 per cent. Royal Bank of Scotland has hiked the rate for new and existing customers on two products, including one from NatWest, from 3.75 per cent to 4 per cent. Santander has hiked the rate for new borrowers on four products by 0.1 per cent. Bank of Ireland yesterday announced a rise of 1.5 points to 4.49 per cent in two stages, affecting 100,000 customers in Britain. Around 850,000 existing borrowers will be hit by Halifax’s move and 200,000 by RBS. Capital Economics calculates that for the average mortgage monthly payments at Halifax would rise £30 per month on a repayment basis and £45 per month on an interest-only basis – a hike of 3-14 per cent.
The good news is that the changes announced so far will increase total UK mortgage payments by only one per cent. The bad news is that this is just the beginning; far more people are already struggling with their mortgages than is usually understood and other costs, such as petrol, are also rocketing at the same time. So why are borrowing costs rising? There is no conspiracy – but regulatory changes are the main drivers, paradoxically given that politicians love easy money yet have introduced changes (some good, some silly) that will lead to the opposite outcome. Mortgages are never financed by money borrowed at overnight rates from the Bank of England. Rather, banks fund their lending using wholesale money (borrowed from other institutions) and deposits; new rules incentivise banks to focus on the latter. Both of these sources of funding have become dearer. It is hard for banks to quickly build up deposits, so they have been forced to offer higher rates – excellent news for long-suffering savers, but bad for borrowers. Banks are now having to offer up to two-three per cent more than the Bank base rate (currently 0.5 per cent): before the crisis, savings rates were usually lower than the base rate. The other change is that banks must now hold more than twice the amount of capital against their loans to protect themselves against defaults; this is expensive and being passed on. The securitisation market remains sluggish, which means loans can’t be sold on, further adding to costs.
Borrowing costs need to normalise. The bubble was caused by excessively cheap money; we can’t delay the necessary readjustment forever. But the pain will be almost unbearable for those caught unaware. They need to evaluate their debt levels, stress test themselves for rate hikes – and deleverage as fast as possible.
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