The mortgage ‘moron premium’ and why home loans may get (slightly) cheaper despite an expected hike in interest rates
The Bank of England is expected to increase interest rates next month, making borrowing more expensive for both businesses and individuals.
Although the rate decides how much businesses and individuals pay to borrow money, mortgage experts believe that the cost of home loans may actually come down, because the derivatives used by mortgage lenders have been pricing in both a levelling off of inflation and interest rates.
A good example of this longer term view was evident when rates started to go up just before the Bank of England actually raised rates in December 2021.
Rates were at a historic low in October 2021, but started to rise that month and throughout November.
This does not mean mortgages will go back to their previous lows but they may not reach the scary levels predicted later last year
Israel Moskovitz, founder of the Avon Group, said: “We are seeing that mortgage experts are suggesting that despite the predicted hike, this could have a minimal impact – mostly because mortgage rates have been reported to fall and stabilise since the autumn, and are now expected to rise further and then fall later this year as the market peaks and troughs. “
Moskovitz added: “With London, we’re expecting there to be a lot to watch over the coming months. Just this week, we’ve heard reports that monthly mortgage payments outside of London could drop by 25 per cent if interest rates and house prices dip as expected.
“With the London market, although payments are expected to drop, the decrease is expected to be less drastic.
Track, stick or fix your mortgage
Borrowers appear to be factoring in a lessening of interest rates.
Carl Watchorn, head of mortgages at lender first direct, said it had seen customer demand change towards shorter and medium term mortgage deals.
“Demand for longer term products such as our 10-year fixed rate has reduced significantly in recent weeks and now accounts for a much smaller portion of applications. Borrowers are now mostly opting for our two and five year term deals.”
Watchorn said there were two main drivers of the reduction in demand for long-term fixed rates.
“The first is that although funding costs have started to come down compared to where they were in early October, they remain higher than they’ve been in recent years. If the longer term economic outlook improves, borrowers may see rates reducing further, making shorter term deals even more attractive.
“There was also a period where our 10-year fixed deal was the lowest rate product we had available, which ultimately increased demand for these deals. However, this is no longer the case, so those choosing a long-term fixed rate product in the current market will likely be doing so because they want to prioritise long-term stability.”
The ‘moron mortgage premium’ and why it still exists
Rajan Lakhani, an expert at money app Plum also expects rates to ease off.
Lakhani said: “Lenders use UK government bond rates and medium-term interest rate expectations to price their products, and both have fallen significantly in the recent weeks.
“However, while mortgage rates have decreased to below six per cent they’ve not fallen by as much as expected, suggesting the so-called ‘moron premium’ from the Truss government is still influencing lenders.
“Given the market volatility during that time, banks have decided to become more cautious and secure higher profit margins, leading to less competition.
“While some lenders have begun to reduce their typical mortgage rates by over one per cent, it’s likely there won’t be major decreases in mortgage rates generally in the next few months as the Bank of England raises interest rates. “
Long or short-term fix rate mortgage
Interestingly, longer-term fixed products have lower rates than shorter-term products at the moment, said Lakhani. “For example, a two-year fix has an interest rate of around 4.75 per cent, while a 10-year fix has a rate of just over 4 per cent.
This is typically not the case – rates are often higher for longer term fixes. They reflect the fact that lenders expect the Bank of England to raise interest rates in the near-term, with rates potentially falling back in the future.
“So if you have no plans to move for some time, a longer-term fix is an option worth considering to mitigate higher rates. Otherwise, if you take a longer-term fixed mortgage and need to exit it, you may have to pay early repayment charges. These charges can be sizeable, unless your mortgage is portable so your mortgage moves with you when you move home. “
Do your housekeeping
To help ensure you get the best rates, make sure your spending is kept in check, avoiding all large expenses if possible and minimise additional borrowing.
Lakhani said: “Do a full up-to-date credit check, check there are no mistakes and no debt to your name, as a poor credit history can affect your ability to get a good mortgage deal. Ensure you’re on the electoral roll too, as this is an easy way to improve your credit score by making it easier for lenders to do their due diligence on you. “
Try and overpay your mortgage
Once you have your mortgage in place, one way of reducing your mortgage payments over time is by paying back extra in advance.
Lakhani said: “If you have a lump of cash saved and you don’t need it for anything else in the short-term, you could put this into the mortgage on top of your regular payments and therefore reduce the amount of interest you ultimately have to pay. “
“This can be particularly beneficial if you still owe more than 60 per cent of your home’s value. These additional payments reduce your loan to value (LTV), so you may get a double benefit since this could mean access to cheaper rates when you remortgage.
Firstly, check if there is a maximum amount you can pay back early without a penalty – it’s typically around 10 per cent but this varies depending on the offer you have.
If you can get a savings account with a higher interest rate than the interest you are paying on your mortgage, it may be that you’ll be better off keeping it in savings and getting that interest than paying off a bit more mortgage.
“As new and competitive interest accounts are hitting the market all the time at the moment, this is definitely something to consider before you commit extra money to your mortgage. And thirdly, if you have debt other than your mortgage that is more expensive, try to make sure you pay that off first. “