Inflation reached 2.5% in June, as a reopened UK economy saw a spending boom across restaurants, bars, and leisure activities.
While this may feel like a far-off issue for you, inflation can have a tangible impact on your personal finances – and, in particular, it could ultimately mean your mortgage repayments become more expensive.
Here’s how inflation can affect your mortgage repayments.
Inflation increases the value of money
Inflation measures the rise in the cost of living from one year to the next.
A 2.5% rise in inflation over a year would mean that goods and services now cost that much more.
So, for example, if you had bought a garden gnome last year for £10, that same purchase would cost £10.25 after a year of inflation at 2.5%.
The Bank of England uses its base rate to try and control the rate of inflation in the UK
Each year the Bank of England (BoE), the UK’s central bank, targets 2% inflation to keep the economy growing.
To attempt to control the rate of inflation, the BoE can change its internal interest rate, known as the “base rate”.
The base rate is the amount of interest that commercial banks and building societies receive on money they hold with the BoE.
In March 2020, the BoE cut the base rate down to 0.1% to promote spending, as Covid ravaged the economy.
This cut encouraged banks to lend and spend their money rather than save it, as they’d receive very little in interest from the BoE. The resultant movement of money then helped to stimulate the flailing economy.
However, having reached 2.5% in June, inflation exceeded the BoE’s 2% target. When inflation becomes too high, the bank can choose to raise the base rate, increasing the interest financial institutions receive on their savings. This encourages them to hold their money, rather than lend it. It can have the effect of slowing down the economy, bringing inflation back within the 2% target.
Inflation could influence variable- and tracker-rate mortgages
One measure the BoE could therefore use to tackle rising inflation is to increase the base rate.
A rise in the base rate would mean an increase in interest rates across the board. This would generally also include mortgage interest rates.
As a result, depending on what kind of mortgage deal you have and how long you have left on it, inflation could have a tangible impact on you.
By and large, fixed-rate mortgages are unaffected by inflation. No matter what happens, repayments on a fixed-rate deal will stay the same by definition, so a rise in the base rate has no impact.
However, if you’re nearing the end of your fixed-rate deal and haven’t yet made plans for what happens next, inflation could affect you.
When a fixed-rate deal ends, you’re typically moved onto your lender’s standard variable rate (SVR). Their SVR could rise in line with a rise in the base rate, which means the rate your mortgage reverts to when your deal ends could be higher than you expect.
Make sure you speak to a mortgage broker and find out your options for remortgaging. Otherwise, when your deal ends, you may end up paying more than you need to.
Variable-rate mortgages use the lender’s SVR to determine their interest rate. So, if the lender decides to raise the SVR in line with a rise in the base rate, you could see your repayments rise too.
A lender can change their SVR at almost any time, regardless of the base rate. If you have a variable-rate deal, you should consider speaking to an expert and looking at deals that could work better for you.
By design, tracker-rate mortgages follow the base rate to determine the interest rate you pay. Currently, with the base rate at an all-time low, tracker-rate mortgages can present a good option for a cheaper mortgage deal.
But, if the BoE raises the base rate, your interest rate will rise too. That means you’ll almost certainly end up paying more in terms of your monthly repayments.
What do experts think will happen?
Covid has made predictions even more difficult to make than ever, and so experts are torn over what they think might happen.
Quoted in the Times, Laith Khalaf, a financial analyst at stockbroker AJ Bell, stated that he thought rates would stay where they are for the time being.
Similarly, the BoE governor Andrew Bailey was quoted in the Financial Times saying that it’s “important not to overreact to temporarily strong growth and inflation”, warning against a “tightening in monetary conditions.”
This suggests that the central bank itself is still being cautious moving forward and may be considering leaving things as they are for now.
In fact, there’s also still a possibility of the BoE making the base rate negative, taking it below 0%. This is an even more drastic step to encourage banks to lend and individuals to spend, as it would mean money being taken off savings each month, rather than added on.
Financial institutions were asked in February how prepared they would be if the bank were to take this measure, meaning the BoE likely sees it as a tangible possibility.
For variable- or tracker-rate mortgages, this could reduce your mortgage rate yet further. In an extreme situation, interest would be taken off the total you owe, rather than added on.
As a result, your monthly repayments would fall, saving you money.
Speak to us
If you’d like to find out what might happen to your repayments, or if you’d like to find the deal that will work best for you in the current environment, please speak to us at Edinburgh Mortgage Advice.
We can give you personalised mortgage advice and scour the market to find the right options for you, no matter what your circumstances are.
Email [email protected] or call 0131 339 2281 to speak to us.
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.