As the Bank of England sets interest rates to an all time low of 1.5%, some borrowers who have come to the end of their fixed or tracker rate mortgage will take cheer in the fact they will be moving on to their lenders low Standard Variable Rate (SVR) mortgage.
Even before the announcement yesterday, the Cheltenham & Gloucester (C&G) said they would lower their SVR by the same amount as any reduction by the Bank of England. This means borrowers on the C&G's SVR will soon see their interest rate alter to just 3.5%.
For some, the temptation to do nothing and remain on the low SVR will be strong. But could your inaction mean you are sleep walking into danger?
We need to examine why rates have fallen so low and what the effects have been as well as what may happen over the coming year...
Firstly, it would seem obvious that the Bank of England are trying to play their part in pulling the country out recession by making borrowing cheaper. But the real problem is a lack of credit, the Banks don't have enough money to lend out, herein lies the problem. This problem will not be solved by lowering interest rates.
What have the other effects of low interest rates been?
With low interest rates our currency has plunged in value. Take a look at the graph below showing the value of the pound v the dollar. What a fall! This is good news for the few British manufacturers left (as our exports become cheaper) but it is very bad news for imports.
We import a great deal in this country - raw materials, food, clothing, oil, cars, all manner of things - all of them are now more expensive because of the the low pound. Eventually, this will lead to price increases in the shops. This will become a real problem as price increases will result in people buying less goods, which will make the recession worse! Exactly the opposite of what a low interest rate policy is trying to achieve.
We may have no choice to put interest rates up. Our government are going to be spending billions of pounds over the coming years. They need to borrow this money and the Bank of England interest rate is used to set the rate at which our government will borrow money. With such low rates on offer, who will want to lend to the UK government to receive a return of just 1.5%?
Think about the credit crunch, what does it actually mean?
Banks are desperately short of funds and have cut back their lending. Part of the money they lend comes from savers. As interest rates fall, savers will start to look for a new home for their savings... may be an account with a foreign bank such as ING or ICIC paying a higher rate than British banks, or maybe putting money into premium bonds or shares. As savers leave and take their money elsewhere, lenders will be even more short of funds.
Low interest rates are simply unsustainable as they do not tackle the problem of the credit crunch. Over a longer period they will make things worse. So people need to prepare themselves for the fact the rates will increase, we just don't know when.
You may be tempted to hold out for a while "lets wait and see what happens"...
Here's the most important point- What about the value of your house?
If you want to re-mortgage, a mortgage lender will look at the 'Loan to Value' of your new mortgage. [This is the percentage of the value of the loan compared to the value of your home.]
Right now, you could get a really good new rate at 60% or 75% or even 85% loan to value. But house prices are expected to fall further this year, at least on paper. This is important when you want to change your mortgage as lenders base the interest rate on the loan to value. By the time you get round to sorting out a new mortgage, how much equity will be left in your house? Will the loan to value be low enough to get a decent rate? Will you still be able to get a mortgage?
It's all very well enjoying the low SVR now, but you need to be aware of the dangers of inaction!
We have a limited window of opportunity to take advantage of these low rates providing of course you have enough equity in your home!
UPDATE: 14th January 2009
We had an interesting meeting with the Business Development Manager of a large mortgage lender today. She made the following point...
Lenders have been put under huge pressure by the government to lower their Standard Variable rate in line with cuts made by the Bank of England. Some have followed, but not all lenders.
Given the current conditions, the lenders would not have necessarily passed on the full cut in interest rates left to their own devices. At the same time rates have been cut, savers have been leaving in search of higher savings rates from foreign banks such as INGand ICIC.
The dual effects of the above mean it is likely that at the point rates do increase, the SVR could be increased by lenders at a much greater rate than any increase in the Bank of England rate. Unless the mortgage is a tracker mortgage, lenders are able to increase their Standard Variable Rate by more than any increase in the Bank of England.
Whilst the ride down as rates have been cut may have been pleasant, as and when rates increase the ride may be a lot more painful!
FURTHER UPDATE: 4th February 2009
Ford and Vauxhallhave both announced they will be increasing the cost of new cars by 5% despite poor sales and government help. This has been blamed on the weakness of the pound. Ford is not increasing the cost of cars anywhere else in Europe. We need to brace ourselves for further price increases over the coming months and year as our imports all suffer at the mercy of the weak pound. Food, clothing, cars, in fact anything we import will increase in price as a result of the low value of the pound - caused by low interest rates. Low interest rates can only be sustained over a short period of time and will cause damage in the longer term. Our opinion is "Don't get used to low rates interest rates as they can not remain low for long!"
