Around 4m UK households will face higher mortgage costs in 2023 with average monthly payments expected to rise from £750 to £1,000.
Bank lending rates are directly influenced by the Bank of England base rate, which increased nine times in the year to December 2022 to 3.5% and is expected to reach around 4.5% in 2023. Mortgage rates are even higher than this base rate because banks add a premium to account for the risk of borrowers defaulting on their home loans. Average mortgage rates are now around 6% from 1.9% at the start of 2022.
Households with variable-rate mortgages, which adjust as the base rate rises, are already feeling this change. But by 2023, about 1.8 million people with fixed-rate mortgages will come to the end of their current agreements. They face an even bigger shock because their payments will skyrocket almost overnight.
Mortgage costs currently make up 22% of the average UK household budget, so it’s important for those looking for a new deal or trying to re-mortgage to understand how mortgage payments work. This will not only help you choose the best deal, but could also help you reduce your payment burden.
How Mortgage Payments Work
Mortgage payment calculations are complex, so use a mortgage calculator (available at your bank or online). I used one to calculate repayments for John, a fictional homeowner borrowing £100,000 to buy a house worth £110,000 (so he has a £10,000 deposit). John chooses a one-year fixed-rate mortgage with an interest rate of 2% and a payment term of 20 years.
This is a repayment mortgage, so John’s payments to the bank comprise two parts: interest (the amount the bank charges John for lending him the money) and principal repayment (which covers the full amount, £ 100,000, which the bank loaned John for his house).
Your monthly payments will be almost £506.
Looking at the breakdown of annual payments, John will pay over £1,962 in interest for the year his rate is set at 2% (marked in red below), an average of £164 per month.
For principal repayment, John will repay just over £4,108 of the amount he borrowed (blue above) in the year he set his rate at 2%, for an average monthly principal payment of £342.
But, because he has a one-year fixed-rate mortgage, John will have to re-mortgage in 12 months. So what if interest rates had risen by then to 5%, for example?
Subtracting the £4,108, John’s mortgage amount would be £95,892 and the term would be 19 years, while his new monthly payment would be just over £652.
John will be surprised to see that his interest payments have risen slightly above £4,724, £394 per month on average compared to £164 on his last mortgage. He’ll also pay less principal now (about £3,103 per year vs. £4,108 before his rate went up):
But if John lived in a different area, he might be paying even more. With a £200,000 mortgage, closer to the UK average, the monthly interest payment would rise from £327 to £822 if rates increased from 2% to 5%.
So is there a way to soften the blow of rising mortgage rates? If you do your homework, it may be possible to reduce your mortgage payments, depending on the specific circumstances of your home.
Here are five ways you can reduce your mortgage burden. (Please note that the following information is not financial advice):
1. Consider your mortgage options
There are a variety of things you could do to provide temporary relief during the current economic downturn, but always remember to ask your lender for details of the fees incurred for any changes.
For example, temporary options include switching to interest-only repayments for some short-term flexibility, but remember that you should still plan to repay the principal you borrow. Or extend the term of your mortgage so you pay less per month but over a longer period. If John were to extend his term from 19 to 30 years, for example, his monthly principal repayment would drop from £259 to £177.
You could also use some of your savings to reduce your loan amount while loan rates are high. Borrowing 90% of the price of your house (meaning you have a 10% deposit) will likely earn you a higher interest rate than if you could put down 25%. And once you have a mortgage, overpaying whenever possible will lower your interest payments.
2. Avoid the standard variable rate
Once your fixed-rate period ends, your mortgage typically automatically transitions to the lender’s standard variable rate, often the highest rate charged. Try to secure a new offer before your current rate ends to avoid this.
3. Keep your help to buy loan
If you bought your home with the government’s homebuyer program (which is no longer available to new borrowers), it may be worth keeping it, rather than moving to a new mortgage provider once the interest-free period ends. This is because the interest rates charged by these schemes are currently much lower than market mortgage rates.
But probably the best thing to do, especially if you’re having financial difficulties, is to talk to someone.
4. Use a mortgage adviser
Independent mortgage advisors often have access to better mortgage rates than are available to anyone on the internet or from a high street bank, for example. For a £200,000 mortgage over 20 years, for example, a rate of 5% vs. 5.25% would save you around £500 a year.
5. Talk to your lender
Many UK banks pledged to ease the pressure on distressed mortgage holders last year. This means that if you’re struggling or worried about your finances, your bank can help you switch to a more suitable offer without having to take another affordability test, for example.
Your bank needs to know in advance that you are worried, so keep an eye on your finances. And while it’s best to speak up before you miss a payment, even if you don’t, you can still seek help and advice from your bank or other services like Citizens Advice.