Interest Rates; Are they too high, too low or about right?

For more than 35 years, the impending arrival of a new football season has resulted in around 25 of us, all long-standing friends, submitting a variety of well-considered predictions to the group’s statistician-in-chief, a retired accountant, who gathers and sorts the data for the ultimate football sweepstake.

Aside from stumping up a £10 entry fee (once upon a time entry was free), participants must predict the top four teams in the Premier League, Championship, League One and League Two, plus the winners of the FA Cup, League Cup and Champions League. No-one has ever got all 19 teams in the correct order and it’s fair to say that your correspondent’s record is mixed: one outright win, when the entry fee was £1, coupled with one shared victory. This is not, for me at least, a money-making extravaganza.

A reminder that submissions to next season’s sweepstake are now required bleeped on my phone earlier this week, prompting a first look at 2023-24’s runners and riders, in particular teams battling to escape the Championship and a return to the Premier League’s promised land of untold riches.

Of the division’s 24 teams, only two, Rotherham and Plymouth, have never competed in the top flight. Within living memory, almost every one of the remaining 22 sides have featured in either the Premier League or old First Division, experiencing the caché of top flight duels at iconic stadia such as Anfield, Old Trafford and Villa Park, the names of which are etched into football’s folklore.

It is always satisfying to see clubs such as Brentford, Bournemouth and Crystal Palace gradually obtain a toe-gold in the Premier League, achieving more than anyone expects and comfortably avoiding relegation without spending ridiculous sums of money on players. Other clubs, however, can experience a run of injuries or loss of form, or else they endeavour to operate with paper-thin squads and watch as several of their players are exposed by more skilful opponents. For them, the dream is often over almost as soon as it begins; the trap-door slowly edges open to ultimately reveal the ignominy of relegation.

If the gradual realisation that relegation was inevitable had to be accompanied by a song, the slower tempo of The Party’s Over, written in 1956 by Jule Styne and Betty Comden, would seem most appropriate:

The tune may also work as a background ‘mood music’ for those who borrowed larger sums of money at historically low rates of interest at almost any point over the past 15 years.

As Bank of England base rates tumbled from 5.5% in 2008 to an unsustainable 0.1% in March 2020, a sizeable number of borrowers took advantage, snapping up assets including property, mostly financed by chunky mortgages, the cost of which barely made a dent on their monthly budget.

However, the most recent rise in base rates, to 5%, has completed a perfect ‘U’-shaped graph covering the 2008-2023 period, leaving thousands of mortgagees understandably concerned.

In truth, changes in short-term interest rates tend not to have a significant impact on borrowers. It’s estimated that approximately 75% of mortgagees currently enjoy fixed-term interest rates; other figures show that in 2019, more than 90% of new borrowers chose a fixed term mortgage. Most will hope that rates start tumbling downward before the end of 2024 and their fixed rate mortgage deal finishes.

Some people are already experiencing the immediate impact of steadily-rising interest rates. An estimated 850,000 homeowners are paying their lenders’ standard variable mortgage rate, an increasingly costly commitment when one considers that, on average, every 0.15% increase in the Bank of England’s base rate equates to a £15.45 rise in the monthly mortgage cost.

The ferocious and sustained impact of rapidly rising interest rates is a genuine cause of concern for some borrowers, many of whom believed that rates would remain at historically low levels, causing them to over-extend by taking out larger mortgages than they may have needed. The bad news is that if inflation remains stubbornly high, the Bank of England’s most effective (or should that be ‘only’?) weapon for bringing it down is the institution’s manipulation of bank interest rates.

There is, however, a glimmer of hope on the horizon. Forecasts made by a series of financial institutions suggest that while we may experience another, smaller, increase in base rates, to 5.25% later this year, they’re expected to fall to between 3.5%-4% by the end of 2024 and stabilise at around 3% to 3.5% as we reach 2025-27.

Such forecasts are entirely plausible, although prudent would-be borrowers may wish to go beyond short-term predictions and consider what economists refer to as the much longer-term ‘neutral rate’, ie the interest rate borrowers should use when making their future calculations.

Interest rate records go back more than 300 years and show that between 1700-1825, they remained at 5%, primarily because usury laws, in place between 1714-1832, prohibited lenders from charging more than this. Over the following century, average rates were slightly higher, although by the 1970s they soared to an unprecedented 17%. Until the most recent flurry of increases, rates have averaged less than 2%.

The point of this statistical splurge is to remind readers that for more than three centuries the UK’s neutral level of interest has been 5%. In other words, when doing your borrowing arithmetic, it makes enormous sense to assume that over the course of 25-30 years, your lender will charge very close to this average.

This week’s lower-than-expected inflation figure of 7.9%, down from last month’s 8.7%, was described as a ‘relief’ for borrowers by Barclays Bank. Nevertheless, there’s still some way to go before interest rates start falling and when they do, folks who over-borrowed between 2008-22 and are currently paying the price of their decision are unlikely to want to have their fingers burnt again.

With all that goes on in the mortgage world, the equity release market holds many similarities. It too is held to account by the effect of longer term interest rates called ‘Swap rates’ and also government gilts. Albeit both of these have traversed the same path as both inflation and the BoE base rate, they are also now showing signs off reverse gear.

The difference however is that equity release interest rates are fixed not just for 25-30 years, but for the lifetime of the mortgagor. This provides the guarantee of knowing the future balance of the plan after the last person has died or moved into long term care.

Rates currently range from 5.87% MER with Legal & General’s Premier Flexible Opal plan upto 8.45% MER on the highest lending product but with limited availability - Just Retirement J6 plan. As can be evidenced, rates are much higher than 12 months ago and akin to the movement in residential mortgage rates.

However, learns the equity release industry has taken from the residential mortgage market to counter the roll-up of interest is the ability to make voluntary payments back to the lender to assist with managing the future balance – which in equity release terms means their ‘beneficiaries’ inheritance’. This policy has subsequently been adopted by the Equity Release Council trade body which now insists that all lifetime mortgage plans have the voluntary payment feature included as standard.

My remit for this article doesn’t extend to the advantages of voluntary payments, however there have been some excellent articles written on this subject previously and can be read here.