Happy Historical Happenstance – A Practical Response to Current Interest Rates
Inflation has been much in the news of late with UK CPI hitting a ten year high of 4.2% in October and surpassing market expectations. Whether this is driven primarily by price rises in household energy costs, petrol, hospitality or wage inflation in different sectors of the economy is a subject for debate amongst the pundits. But what financial markets and commentators expected at the start of November was that in response the Bank of England (BoE) would hike interest rates from their current all-time low of 0.1%. The BoE did not, which generated a slew of unfavourable comments and the charge of being an “Unreliable Boyfriend”, directed at the Bank’s governor Andrew Bailey.
Inflation has been much in the news of late with UK CPI hitting a ten year high of 4.2% in October and surpassing market expectations. Whether this is driven primarily by price rises in household energy costs, petrol, hospitality or wage inflation in different sectors of the economy is a subject for debate amongst the pundits. But what financial markets and commentators expected at the start of November was that in response the Bank of England (BoE) would hike interest rates from their current all-time low of 0.1%. The BoE did not, which generated a slew of unfavourable comments and the charge of being an “Unreliable Boyfriend”, directed at the Bank’s governor Andrew Bailey. This followed the label attached to his predecessor, Mark Carney, when it was felt that he gave a lack of clarity in hints over future interest rate rises.
My personal interest in this as a consumer and investor were the practical lessons learned from it. I can appreciate the delicate balancing act facing Andrew Bailey and his colleagues on the Monetary Policy Committee as to how far the factors driving inflation are transitory, whether rate rises would imperil a nascent economic recovery to control this threat of rising inflation and, if so, when and how quickly they hike interest rates. But I cannot predict or control any of these individual factors or the decisions they lead to. Therefore, as an individual whose priority is to protect his own domestic balance sheet my observations at the time were as follows:
- 5-year fixed mortgage rates in the UK are currently close to an all-time low (see below), but I cannot predict the bottom.
- Given the focus on inflation I think it is unlikely that these mortgage rates in five years’ time will be as low as they are today - although this is just my opinion.
- Like many people my biggest household liability is/are mortgage(s).
- Combining the above points seems to offer a historically unusual opportunity to make significant inroads into my largest financial obligation.
Just how unusual is this historically in the UK? It has been possible up until the last month or so to fix mortgage rates at around 1-1.5% for 5 years versus 5-5.5% back in 2010 according to BoE data. If you take the data back to the start of the series in 1995 the rate then was closer to 9.5%, whereas borrowers of my parents’ generation were familiar with double digit mortgage rates in the seventies and eighties, even up to 15%.
So, to be able to fix a mortgage rate for five years at such an unusually low level truly felt like the happy coincidence of my previous mortgage term coming to an end, which provided the push to get a new mortgage offer, and the historical happenstance alluded to above.
However, just fixing an interest rate on its own does not reduce outstanding liabilities. As a household we have taken a three-pronged approach to hopefully make the greatest inroads that we can within this fortunate five-year window. Firstly, continuing to make the same monthly payments as we were doing previously with a significantly higher mortgage rate creates a significant overpayment and in itself loan reduction. Secondly, annual capital repayments keeping within the penalty free amounts permitted by the lender’s policy - typically 10-20% of the mortgage. Finally, contributing larger amounts than in step (2.) to an investment account both on a monthly basis as well as topped up from annual bonuses harnesses the power of the financial markets to do some of the heavy lifting. There are no guarantees with this part of the equation, capital is at risk and if capital gains are realised then tax may also be due, hence the direct repayments made in the first two parts of our approach to provide a safety net. This scenario illustration is based on my own personal circumstance and may not be suitable for everyone.
How will this all work out? Ask me in five years…
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