Shift Your Perspective

As we grapple with an evolving financial landscape, there's one trend that's proving to be more significant than many had initially thought: the steady and persistent rise of interest rates and their subsequent impact on the mortgage market.

This isn't a minor blip on the radar but rather a significant shift that requires serious consideration, particularly from older generations (including those who had mortgages in the early 1990’s) who might underestimate the true implications of this trend on today's younger generations.

Casting our minds back to only last year, September 2022. Interest rates had just increased from 1.75% to 2.25%. The predictions then were for a gradual increase, with rates expected to peak at 4.75%.

Fast forward to now, and rates have already escalated to 4.5%. With the Bank of England's Monetary Policy Committee due to convene tomorrow with the knowledge that inflation, stubbornly, persisted at 8.7% in May when a decline was optimistically anticipated.

They will tomorrow increase rates by at least 0.25%, but I feel they may go straight to 5% with a 0.5% rise, which would take us beyond the peak that was predicted last September. These figures serve as a stark reminder of the speed at which these shifts are taking place.

Older generations might fondly remember weathering the storm of skyrocketing interest rates during the ‘70s, ‘80s, and ‘90s, and thus may perceive the current rates as relatively mild in comparison.

After all, those past decades witnessed rates well into double digits with rates peaking at various times; 17% in November 1979, 13.38% in March 1985 and 14.88% in October 89.

Indeed, the rates were higher than the current figures continuously from 1975 until as recently as September 2001. However, this viewpoint fails to take into account the significant shift in financial dynamics that have occurred since those periods.

The crux of the matter here isn't just the numerical value of the interest rates. What is more critical is the affordability of these rates, especially for mortgage holders.

The pivotal factors are not just the rates themselves but the amount being borrowed and, equally important, the borrower's disposable income in comparison to these payments.

In this regard, let's consider the concept of the "equivalent" interest rate.

This takes into account debt burdens, incomes, mortgage terms, and rates, painting a very different picture of financial reality.

For instance, consider 1980 when the official Bank of England interest rates averaged 14.2%.

Yet due to lower debt levels and higher incomes relative to repayments, this rate was, in affordability terms, EQUIVALENT to a 3% rate in today's terms.

Through this lens, we see that our current rates are not significantly lower than those of the 1970s but are strikingly similar when adjusted for affordability.

If rates increase today to 5%, we'll be reaching levels of affordability comparable to those just before the financial crisis.

And if rates rise to 6%, which the markets are now predicting will happen by the end of the year, it’s not totally implausible that the squeeze for those with mortgages could actually be worse than in the 1990s, which instigated the worst housing crash in modern history. The following is a summary of recent research from The Institute Of Fiscal Studies:

• Recent hikes in interest rates may cause 1.4 million people to lose 20% of their disposable income due to rising mortgage payments; mortgage holders in their 30s and those in London will be most affected.

• Over 14 million adults have a mortgage. Those with fixed-rate mortgages are initially protected from rate rises, but will be exposed to higher rates when these fixed terms end. Approximately a quarter of mortgages will end their fixed term between Q4 2022 and Q4 2023.

• From March 2022, the average two-year fixed-rate mortgage has increased from 2.65% to 6%. If rates persist at this level, mortgage payments will rise on average by £280 per month, exacerbating already existing financial strain for families.

• Mortgage holders in their 30s are projected to experience the largest increases in monthly payments, paying nearly £360 more on average, which equates to an 11% decrease in their disposable income. 1.4 million mortgage holders, half of whom are under 40, will see their disposable income reduce by over 20%.

• Londoners will be most impacted by rising mortgage payments, with their monthly payments increasing by an average of £520, or around 12% of disposable income. Areas in the South East, East, and South West of England will see their disposable income decline by over 9% on average.

• If interest rates remain at 6%, around 60% of mortgage holders, equating to 8.5 million people, will be spending more than a fifth of their family income on mortgage payments. This is a significant increase compared to 2008, the previous high.

• Renters are also experiencing substantial increases in housing costs and have traditionally paid more than mortgage holders. However, the benefit system offers little safety net for low-income mortgage holders compared to renters.

• The surge in mortgage costs could not occur at a worse time, given the current pressures on cost of living due to high food and energy price inflation.

Grasping this concept of “equivalent interest rates” is absolutely crucial. While this understanding is prevalent among housing experts, it seems there's a lack of wider consciousness, particularly among the older generation.

The potential repercussions of unrestrained borrowing and the intensifying pressure on the Bank of England to elevate rates are far-reaching and formidable. There's a tendency to resort to the Economics 101 playbook - increasing interest rates to contain inflation - without contemplating the financial distress this approach can instigate.

The next time you hear about people struggling with their mortgage, please don't casually dismiss these concerns by merely comparing today's interest rates to the historical highs you once weathered.

Instead, consider the above underlying dynamics and lend an ear to the concerns of younger generations wrestling with their mortgage payments.

While the interest rates may appear insignificant relative to what you've encountered, the weight of the burden is equivalently heavy.

Financial wisdom and empathy should transcend generational boundaries.