While we have known for some time that interest rates would eventually rise and borrowing would be less easy, 1 December became something of a demarcation point between the extended period of cheap, easy money and a new cycle with higher interest rates and tighter lending. That was the day the CCCFA (Credit Contracts and Consumer Finance Act) came into force. Since that date, there has been much confusion for lenders, borrowers and advisers.
Lenders are now required to be more responsible in their lending – ensuring that loans are both affordable and suitable for borrowers. This means they collect significantly more information on borrowers, scrutinising their spending patterns and looking at their ability to cover mortgage payments in the event that interest rates rise another 2-3% more than current rates.
Mortgage pre-approvals granted before 1 December, especially those that were not linked to a specific property purchase, now need to be reassessed so that lenders can comply with the CCCFA. Along with that, mortgage interest rates have jumped around 2% from their previous low and are likely to rise further. Lenders will be testing the ability of borrowers to pay interest rates of up to 7% to ensure their borrowing will be affordable in future.
For those who already have their mortgages in place, the news is not good either. Borrowers commonly fix their interest rate for 1-2 years and over the remainder of the year, many mortgages taken out at the bottom of the interest cycle will move to interest rates around double what they were.
Whether you are a new borrower or an existing borrower, it’s time to reassess the affordability of borrowing going forward and to take action to avoid financial stress.
I have always been a fan of the ‘as if’ principle when it comes to working out if something is affordable or not. Whether it is looking at the affordability of buying a new or bigger home, taking time out of the work force to bring up a family, or retiring, the ‘as if’ principle is a great way to test affordability while adding to your savings. How it works is that you act ‘as if’ you are already in your scenario of increased expenses or reduced income and try living accordingly. The difference between your actual and planned future expenses or actual and planned future income is put into your savings account and you can test what it feels like to living on a tighter budget while adding to your savings.
Going forward, it is going to be important to be able to prove to lenders that you can live comfortably and still be able to make mortgage payments at interest rates up to 2% higher than they are currently. The best way to do this is to live for a few months ‘as if’ you are making those payments by saving the difference between your current outgoings and what your outgoings would be with a mortgage at a higher interest rate. This will be particularly important for first home buyers and those wanting to take on a bigger mortgage.
Borrowers who have been enjoying low interest rates for the last couple of years need to adjust to a new world of higher interest rates before they refix their interest rates at the new, higher rates. Check with your mortgage broker or use one of the online calculators on your bank’s website to work out what your repayments will be at the new rates and start living now ‘as if’ you are paying those rates. This will allow you to try out what it will be like on a tighter budget so that you make changes and adjust your outgoings to fit. Its much better to ‘practice’ a new way of living before you are thrown into it and suddenly find yourself in financial difficulty.
To add to our woes, inflation is sitting at around 6% and could go higher in the short term, while wages are lagging behind. This year could well be the year of the ‘big squeeze’ with higher borrowing costs, high inflation and lagging wage growth. It’s time to prepare for a new way of living.