Introduction
As the expiration date of my fixed rate mortgage deal approaches, I am faced with the daunting task of deciding between a fixed rate mortgage and a variable tracker mortgage. The crucial factor in this decision hinges on the direction of interest rates in the coming months. While conflicting signals about inflation and interest rates make it challenging to predict accurately, I will explain my rationale for opting for a variable tracker mortgage over a fixed rate.
Weighing the Mortgage Options
At present, I have two choices: a 5-year tracker mortgage linked to the base rate, currently at 5%, or a 2-year fixed rate mortgage at 4.73%. Similar options are available for a 5-year contract.
In the short term, there is minimal disparity between a variable tracker mortgage and a fixed rate mortgage. However, within five years, interest rates could experience significant fluctuations. With a fixed rate mortgage, I would have certainty in knowing the exact payment amount, whereas with a tracker mortgage, the monthly payment could increase or decrease.
The primary advantage of a fixed-rate mortgage is the ability to lock in the interest rate, providing stability over the next 2, 5, or 10 years. This safeguard eliminates the risk of being caught off guard by sudden rate increases, as witnessed during the housing crash in the 1990s when interest rates reached 15%, leading to repossessions and a prolonged crisis.
Nevertheless, while a mortgage rate of 4.7% may seem favorable in historical terms, it is relatively high compared to the past 15 years following the 2007 financial crash. Those who opted for tracker mortgages before the crisis benefitted from ultra-low interest rates, with some lucky households paying near-zero mortgage payments due to products offering rates below the base rate.
Speculating the "New Normal" for Interest Rates
The pivotal question revolves around the future path of interest rates. To find an answer, we must consider the prospect of inflation and the stance of central banks worldwide.
Over the past two years, inflation has consistently exceeded the forecasts of central banks. This unexpected rise in inflation prompted swift and greater-than-predicted interest rate hikes. Initially, the Bank of England adopted a dovish approach, hoping inflation would subside naturally. The belief was that inflation resulted from temporary supply-side shocks, such as rising oil and gas prices, which also contributed to increased food prices. However, the Bank is now concerned that this temporary inflation has become embedded and persistent.
The Bank's acknowledgment of a wage-price spiral and its commitment to raising interest rates as necessary to bring inflation down to 2% carries significant implications for interest rates and the housing market. It reveals the Bank's heightened hawkishness and determination to tackle inflation.
While these developments may prompt some to secure a fixed rate mortgage promptly, I am still inclined to hedge my bets on the potential for falling interest rates. Allow me to present my reasoning, and you can decide whether it resonates with you.
Firstly, the Bank's more vigilant tone aims to reinforce its credibility in combating inflation. By displaying seriousness in reducing inflation, they hope to moderate wage demands and price increases.
Secondly, current inflation primarily stems from cost-push factors, with the Bank's analysis suggesting no excess demand contributing to inflation. This is understandable given the weak economic growth and the UK's output gap, with GDP still below pre-COVID levels. Furthermore, the rising interest rates will further dampen demand. Those with larger mortgages are likely to be paying hundreds in addition to their current outgoings if the Bank opts to increase Bank Rate by just an additional percentage point.
Thirdly, while gas and oil prices have fallen significantly since last summer's peak, this decline has yet to manifest in the consumer price index, partly due to the energy price guarantee. However, the inflationary effect of rising gas prices will drop out of inflation in the near future.
Fourthly, although food inflation has recently reached record levels of 20%, global food prices have actually decreased in the past few months. There is, however, a time lag before these price changes are noticed in stores due to fixed contracts. But new contracts will reflect substantially lower commodity prices, and supermarkets predict that food prices will soon start to decline.
Fifthly, are we really witnessing a wage-price spiral as claimed by the Bank? Real wages are falling, with nominal wage growth at 6% but still 4% below inflation. Workers lack the bargaining power to demand higher wages to keep up with inflation, as evidenced by numerous strikes. This situation is far removed from the genuine wage-price spirals experienced in the 1970s and 1980s.
Sixthly, real interest rates have experienced a long-term decline across developed nations, driven by factors such as demographics. The aging population and lower rates of economic growth have led to a surplus of savings, resulting in diminishing interest rates. Although the UK has a relatively younger workforce due to higher immigration, the aging population and low economic growth are likely to contribute to sustained low interest rates. Given the current climate of sluggish growth and low productivity, it seems improbable that interest rates will rise significantly. In fact, it’s concerning that the current base rate of 4.5% may impede economic growth and lead to a sharp decline in inflation and interest rates.
Assessing the Risk of Variable Interest Rates
While the analysis above supports the likelihood of falling interest rates, it is crucial to acknowledge the potential risks, particularly those arising from unforeseen events. Geopolitical incidents, such as issues between China and Taiwan, could trigger a renewed surge in inflation. Disruptions in supply from China would not only cause inflationary effects but also impede economic growth, thereby limiting the extent to which interest rates can rise.
Personal Mortgage Decision-Making
Reflecting on past experiences, I had previously chosen a five-year fixed-rate mortgage, which proved financially advantageous and saved me a significant amount of money. In hindsight, I realise that opting for a 10-year fixed-rate mortgage during a period of exceptionally low interest rates would have been a wiser decision. Regrettably, I did not consider this possibility in 2021 due to my familiarity with historically low rates, failing to anticipate the events of 2022.
Presently, I think the case for falling interest rates is a strong one. While there is a chance of facing higher mortgage payments, I believe the odds favour a decline in rates.
Conclusion
In conclusion, the decision between a fixed rate mortgage and a variable tracker mortgage depends on various factors, particularly the anticipated direction of interest rates. While there are arguments supporting the stability of fixed rate mortgages, I am willing to take a risk and favour a variable tracker mortgage due to several factors indicating a potential decline in interest rates. However, it is crucial to acknowledge the associated risks, such as unforeseen events triggering inflationary surges. It is essential to evaluate personal circumstances and seek professional advice when making mortgage choices.