How to protect your mortgage in the bond market storm: Experts reveal exactly what borrowers can do

Mortgage rates are on the rise after Britain’s borrowing costs hit highs not seen for nearly three decades earlier this week.

Fears interest rates may need to rise, due to inflation triggered by a flare-up in the conflict between the US and Iran in the Middle East, have been behind a bout of global bond-market turmoil.

But the tempestuous political climate, Labour’s struggle to balance the books, and the looming first Budget for new Prime Minister Andy Burnham and Chancellor John Healey on October 28 are exacerbating the situation for the UK.

The knock-on effect is bad news for mortgage borrowers, with some lenders already raising rates and brokers warning of more hikes to come.

We explain what to do if you need to remortgage, are planning to buy a home or simply want to keep on top of your mortgage costs.

Bonds and the mortgage market

The yield on 30-year bonds, known as gilts, hit its highest level since 1998 of 5.94 per cent, in mid-week, while ten-year gilts reached 5.26 per cent, the highest level since the financial crisis in 2008.

Bond yields, the key measure of interest rates on debt in financial markets, have fallen back slightly from their highs earlier this week, but there are still substantial market concerns over the future direction of inflation and interest rates.

Oil prices have climbed, with Brent crude rising to $97.62 a barrel yesterday, and the boss of British Gas owner Centrica warned about gas storage and energy prices this morning.

Inflationary pressure increases expectations that the Bank of England will raise interest rates, which feeds through to investors demanding a higher yield to buy bonds.

If this continues, the knock-on effect will be to raise mortgage rates for households across Britain. Higher gilt yields drive up the cost of borrowing for banks, and they pass this on to their customers.

Coventry Building Society has already announced mortgage rate increases in reaction to the bond market chaos, with brokers urging borrowers to act quickly because other lenders will follow.

Sonia swap rates, the inter-bank lending rate on which banks base the price of their fixed mortgages, are close to 4.5 per cent. These wholesale rates can react rapidly to changing inflation expectations and financial market uncertainty. As recently as the end of June, the rate was 3.97 per cent.

David Stirling, an independent financial adviser at Mint Wealth, says: ‘This is the market doing what it always does when geopolitical risk flares up, money markets get nervous, gilt yields move, and swap rates – which is what actually prices a fixed mortgage – shift within days.

‘Coventry won’t be the last, as the lenders watch each other like hawks. Once one has repriced, the rest follow within a week purely to avoid being the cheapest rate on the market and getting swamped with applications they can’t fund at that price.’

What to do if you need to remortgage soon

It is possible to reserve a new mortgage offer as early as six months before your current one ends, though some lenders will limit it to three months.

Someone with a mortgage deal ending in March next year or earlier should try to lock in a rate at today’s prices. If the situation changes and rates begin to fall again, it is usually possible to switch to a new one until just before the new mortgage begins.

Don’t automatically remortgage with your existing lender, as there could very well be cheaper deals to be had elsewhere. Even a rate which is 0.1 per cent lower than your lender’s best offer could potentially save you hundreds of pounds per year.

Use an online tool such as This is Money and L&C’s mortgage finder to see the best rates you can get, and consider using a mortgage broker to help you find the right deal for your circumstances. Many are fee-free for the borrower and charge their fees to the lender you choose instead.

Doing nothing is the worst thing you can do. Anyone who allows their current deals to expire without remortgaging will fall on to their lender’s standard variable rate – the default rate borrowers are put on when their fixed rate ends. This can be 7 per cent or even higher.

Craig Fish, director at London-based Lodestone Mortgages, says: ‘We’re all living on a knife edge, and if your deal ends within six months, act now, because waiting is how people get hurt.

‘Gone are the days of chasing rock-bottom rates. The ones who move early are the ones who stay in one piece.’

Use your savings to make overpayments

If you are worried about your mortgage payments rising in future, you could consider using savings to pay down some of it, or making extra payments each month to chip away at the balance.

Paying off more of the mortgage balance could reduce the monthly payments as interest rates rise, especially if it allows you to get a cheaper deal. Lenders usually offer cheaper mortgage rates to those who own a bigger stake in their home as they are less risky.

Rates usually improve when someone reaches 10 per cent equity, 15 per cent, 20 per cent, 25 per cent or 40 per cent.

So if you currently have 24 per cent equity in your home but can get that up to 25, cheaper deals could be available.

Only do this if you don’t need the money as a rainy day fund or to pay down other more pressing debts – and be careful you don’t go over your lender’s limit for overpayments, as they will probably levy what is known as an early repayment charge.

Most fixed-rate mortgage deals allow borrowers to make overpayments amounting to up to 10 per cent of the total outstanding amount each year, although some allow up to 20 per cent.

Lengthen the mortgage term

Another way to lower your monthly bill is by lengthening the term when you come to remortgage. This could at least give you some much-needed short-term relief.

The mortgage term is the number of years someone agrees to repay their mortgage for. Historically, this was 25 years for nearly all customers. But now borrowers often choose 30 years or even longer.

By lengthening the remaining term of a mortgage, for example extending it from 20 years to 25, a borrower spreads their repayments over a longer period of time. This reduces the monthly cost.

However, the downside is that interest is charged for a longer period, so the total you pay over the course of the loan will increase. It can add tens or even hundreds of thousands of pounds to your costs.

It is therefore not a decision to be taken lightly, and is best used as a short-term fix with the idea of shortening the term again when your finances allow.

Someone with a £200,000 mortgage paying 4.75 per cent interest over 20 years would face monthly repayments of £1,292, paying a total of £310,067 over the lifespan of the mortgage.

Conversely, someone with a £200,000 mortgage paying the same interest rate over a 35-year term would face monthly repayments of £977.

However, they would pay £410,396 over the lifespan of the mortgage – £110,212 more than on a 20-year term.

Consider switching to interest-only

Another way borrowers can reduce monthly payments is to switch to an interest-only mortgage. Again, this comes with a warning and should be viewed as a temporary measure.

With an interest-only mortgage, borrowers will only pay the interest each month, with the loan amount remaining the same.

This differs from a repayment mortgage where homeowners pay back a part of the loan, as well as the interest, each month until they eventually pay off the mortgage.

With interest-only, the monthly payments will be lower – but at the end of the mortgage term, the full amount borrowed will need to be repaid in one lump sum. If the homeowner doesn’t have the means to do so, they will need to sell their home to pay back the bank.

However, it is possible to fix for two or five years on an interest-only deal, and then switch back to a repayment option. This means you could significantly cut your monthly costs down during two years in the hope that rates are lower when you next need to remortgage.

But the temptation to stay on interest-only indefinitely must be avoided, unless you have another means of paying it back at the end of the term.

Borrowers seeking an interest-only mortgage for their own home are subject to much stricter lending criteria, so it is worth speaking to a mortgage broker before you take this route.

Should you roll the dice with a tracker mortgage?

Switching to a tracker mortgage is another option – though this will involve rolling the dice over your future monthly costs.

Tracker mortgages follow the Bank of England base rate, plus a certain percentage on top.

For example, someone might be given a tracker mortgage at base rate, currently 3.75 per cent, plus 0.3 per cent.

This would set the rate they pay at 4.05 per cent. If the base rate rose to 4 per cent, though, their mortgage rate would rise to 4.3 per cent. If the base rate was cut to 3.5 per cent the tracker rate drops to 3.8 per cent.

With fixed-rate deals rising, tracker rates now look like good value. The lowest two-year tracker for someone remortgaging is 4.04 per cent while the lowest two-year fixed-rate deals start from 4.47 per cent and the lowest five-year fixes start from 4.65 per cent.

It means that some people opting for trackers would have to see the Bank of England hike interest rates to 4.25 per cent to be worse off than if they fixed at the moment.

Tracker mortgages also tend to come without early repayment charges. This means that, unlike fixed deals, they can often be paid off, overpaid or switched away from without penalty.

It gives homeowners on a tracker a crucial get-out, in the case that the base rate rises – and means they could switch to a fixed-rate deal if those became cheaper.

But it is predicted that the base rate will stay the same for some time, making trackers a more costly option for many.

Nicholas Mendes, of broker John Charcol, says: ‘The Bank of England held the base rate at 3.75 per cent in July, and the next decision on 17 September is widely expected to be another hold, which is exactly the kind of backdrop that makes a tracker a harder sell right now.

‘A year or two ago, choosing a tracker was a reasonable bet on rate cuts arriving. The market is not pricing that in, with the cost that trackers are linked to expected to keep climbing for the next year or so before it levels off, so a tracker taken out today is more likely to get more expensive than cheaper over its early life.

‘Trackers still suit someone planning to sell or remortgage again within a year or two and wanting to avoid an early repayment charge, since most come without one, but as a way of catching a falling market, the timing does not look right just now.’

What about if you’re planning to buy?

Home buyers need to put down £18,200 more on their deposit than they would have at the start of this year on average in order to counter the impact of higher mortgage rates, according to analysis by Zoopla – and that is before any further rate spike.

This could be reason enough to sit tight and wait for lower rates in the future – but looking to buy during higher rates could also mean less competition from other buyers.

There is also every chance of haggling better deals off the asking price, so don’t necessarily be put off by higher mortgage rates.

Mendes adds: ‘Get affordability checked early so the budget is clear, then move to a full application as soon as a property is found,’ he says. ‘That is the point a rate is actually reserved, typically for six months while the purchase goes through.’