The recent decision by the Bank of England to raise interest rates has sparked significant concerns and implications for homeowners, renters, and the overall lending landscape. With inflation remaining stubbornly high at 8.7% in May (according to the Office for National Statistics, more than four times the government’s target), the 0.50 percentage point increase was widely anticipated. This move brings the Bank Rate to its highest level since 2008 and with the financial market predicting that interest rates will continue to rise, potentially reaching 6% by early next year, it will continue to add further strain to borrowing costs.

This rate rise marks the 13th since December 2021 when the Bank rate stood at a mere 0.1% and aims to reign in inflation, bringing it back down to the 2% target. However, the direct impact on millions of homeowners cannot be ignored, as their UK mortgage rates are linked to the central bank’s base rate. Renters are also likely to experience a ripple effect, facing increased payments as buy-to-let landlords pass on higher mortgage repayments.

Research conducted by the National Institute of Economic and Social Research, suggests that this latest interest rate increase by the Bank of England could push 1.2 million UK households (accounting for 4% of households nationwide) to exhaust their savings by year-end due to higher mortgage repayments, with some households facing paying an additional £5,000 a year on their mortgages. Consequently, many households with mortgages will teeter on the brink of insolvency.

New adjustments to mortgages 

The trajectory of mortgage rates has been influenced by various factors, with the first surge occurring after last September’s mini-Budget, which initiated market uncertainty and led to a historic plunge in the value of the pound. Major lenders responded by withdrawing low-rate mortgage deals and reintroducing them to the market at higher prices, with this reduction in options making it challenging for borrowers to find favourable mortgage terms.

While mortgage costs have experienced some correction since then, recent trends indicate a renewed surge in lenders raising the cost of deals, mirroring the relentless climb of the Bank rate in the face of elevated inflation. While many mortgage lenders had already accounted for the most recent rate rise in their pricing, a significant number continue to withdraw deals and increase the cost of fixed rates.

In the U.K. Finance Minister, Jeremy Hunt has unveiled a government charter that has been agreed upon by banks, mortgage lenders, and the Financial Conduct Authority (FCA). These measures include temporary changes to mortgage terms in line with FCA rules such as switching to interest-only payments for six months and extensions to mortgage terms to reduce monthly payments. Both will be offered without affordability checks and the assurance that people’s credit scores won’t be negatively impacted. Moreover, recognising the potential risk of homeowners losing their homes, lenders have agreed to provide a 12-month grace period before initiating repossession without consent.

We are now seeing lenders stepping up and proactively contacting customers to discuss support options, with the FCA seeing over 2 million customers receiving active support from lenders to manage their finances including budgeting tools, debt advice and mortgage forbearance.

But this increase begs the question: how do lenders adapt to the evolving landscape of rising interest rates and what is the difference this time round?

The challenges lenders face  

When interest rates rise, the valuation of equities held by firms declines, thereby reducing their net worth. This diminished net worth, in turn, reduces the amount of collateral firms can provide for their loans. With reduced collateral, firms become more vulnerable to potential losses, prompting lenders to adopt more cautious lending standards. To account for the increased risk, lenders charge higher interest rates, further raising borrowing costs. Consequently, this tighter lending environment leads to fewer loan approvals and a slower pace of lending for both consumers and businesses.

Read the full article on Finextra here.