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Borrowers warned of mortgage rate rise

Good economic news makes a rise in interest rates more likely. We look at how homeowners can prepare for higher monthly mortgage payments.

House with a pound coin garden path

Good economic news may have a sting in the tail for UK homeowners.

Last week, the government revealed that unemployment in Britain had fallen to 2.32 million - which means that 7.1 per cent of working-age people can't find a job.

And the Office for National Statistics has revealed that in 2013 the UK economy grew at its fastest rate since 2007, when the financial crisis began.

These positive pieces of economic news are welcome, and will hopefully feed through into a rise in wages and living standards.

Interest rate rises likely

But they also make it more likely that the Bank of England will raise interest rates in the near future, thereby pushing up borrowing costs.

This is good news for savers but will mean more expensive rates for borrowers – including higher monthly mortgage repayments for millions of homeowners.

The Bank of England base rate has been stuck at 0.5 per cent for nearly five years now.

Low interest rates are thought to be necessary when the economy isn't growing very quickly because they encourage individuals and businesses to spend rather than save.

Higher interest rates curb cost of living rise 

But when the situation improves, interest rate rises may be needed to act as a brake on fast growth.

Higher rates can help avoid the high levels of inflation – rises in the cost of living - that can result when demand for goods and services outstrips supply.

Bank of England governor Mark Carney said last year that a rise in rates would be considered when unemployment dropped to 7 per cent.

However, he now suggests that a rise might not be implemented immediately if and when this target is reached.

How will you cope with mortgage rate rises?

Piggybank, toy house, coins and a keyNevertheless, it makes sense for homeowners to prepare for higher borrowing costs.

If you are on a tracker deal or a lender's standard variable rate, your monthly mortgage repayments will almost certainly rise if the base rate goes up.

Even if you have a fixed-rate loan, you will probably face higher costs when it comes to an end and you have to remortgage.

David Hollingworth from mortgage broker London & Country says that borrowers should think about how they will cope with higher repayments.

Preparation is key

"The Bank of England has been clear to indicate that rates are unlikely to climb soon even though the unemployment threshold is being neared," he says.

"Therefore although I don't expect rates to rise in the short term, preparing now will certainly make life easier in the future.

"At worst, it makes the low rates work harder for you."

Mortgage overpayments could be the answer

One way to soften the eventual blow is by overpaying on your mortgage now.

And this makes more sense given today's low returns on savings accounts, Hollingworth adds.

"Overpaying is a good way of making the most of the current record low in interest rates," he explains.

"Cutting the mortgage balance more rapidly will help to save interest and make life easier when rates do inevitably start to climb."

How £100 can shave two years & £5,500 off your mortgage

The average mortgage debt in the UK is just over £100,000, according to the Council of Mortgage Lenders.

Hollingworth illustrates the potential benefits of overpaying on a £100,000 mortgage, for someone with 15 years left on their loan, with a current rate of 4 per cent:

  • At the moment, monthly repayments are £740, but by increasing them by £100 a month, the loan would be paid off two years and three months early;
  • This would also save more than £5,500 in interest charges;
  • Overpaying by £200 a month would cut the mortgage term by three years and 11 months, and save £9,439 in interest.

But Hollingworth warns against devoting every spare penny to overpayments.

"It could prove complicated to access the cash at a later date if you need to get hold of it," he says.

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Chris Torney

Chris Torney

Chris is the former personal finance editor at the Daily Express. He's been a journalist for more than 10 years and contributes to a wide range of finance and business titles.Read more from Chris