Pretty much everyone agrees that the Bank of England is going to raise base rates at some point. But what effect will that have on your monthly mortgage payments?
There are two factors at play here; firstly, the extent to which the official Bank base rate rises, and secondly the difference between base rates and the rates actually charged by lenders (the spread).
In terms of base rates, the Bank says that any rise will be gradual and that the rate will remain well below normal for an extended period.
City forecasters currently expect that the official base rate will rise from its current 0.5% to 0.8% by this time next year, to 1.6% a year later (May 2016) and 2.4% a year after that (May 2017). To put that in context, the rate ranged from 4.75% to 5.75% between 2005 and 2007.
In other words, for the foreseeable future, the official bank rate is going to be less than half the levels that prevailed before the crisis.
But what you actually pay for your mortgage depends on the difference between what your lender pays (to savers or others) to borrow the money that they lend you and the amount they charge you.
Of course, the base rate influences those figures, but there are other factors at play, notably how much competition there is between lenders.
Between 2005 and 2007, the average ‘spread’ – the difference between the base rate and a typical 3 year fixed rate mortgage – was around 0.5%. Then came the ‘credit crunch’ and the spread soared as banks and building societies desperately tried not to lend (see graph).
When rates fell to 0.5% in March 2009, the spread between the official base rate and the average rate for a 3 year fixed rate mortgage rose to almost 4% (3.91%). Since then, the spread has very gradually narrowed to 2.46% as competition between lenders has returned and their balance sheets have improved.
In its latest inflation forecast (not for the fainthearted) the Bank says that it thinks the spread will fall further, to 2% by next year. If that is right, the expected increase in base rates of 0.3% by this time next year will be more than offset by a reduction in the spread charged by lenders of 0.46%.
It is highly unlikely that spreads will shrink again to as low as 0.5%, so mortgage rates certainly will rise. But the first increases in base rate might have little or no impact on actual mortgage payments.
In the medium term, a spread of 2% (as expected by the Bank of England) coupled with market expectations of a base rate at 2.4% suggest an average rate for a 3 year fixed term mortgage in 2017 – two and a half years from now – would be 4.4%. That is lower than at any time between 1995 and the start of 2009.