The evidence is mounting that 2022 has seen a regime change for interest rates. Quantitative tightening (QT) is the new quantitative easing (QE). Everyone should stress-test their mortgage and other debts to see how they’d handle higher rates.
There are two main things to consider:
- The cost of servicing debt (a function of interest rates, plus spurious add-on charges)
- The ability to get debt if you need it (how willing are banks to lend)
Both will likely get worse for most borrowers as money tightens.
Of course if the screw is really turned we will see second-order effects.
For instance markedly higher rates could cause the housing market to slow or unemployment to rise. That could hit your finances directly (you lose your job) or indirectly (a stock market or house price crash).
Keep going with such extrapolation, however, and you begin to sound like the economic nerd cousin of Stranger Things’ Dustin Henderson.
“High rates will crush growth even as de-globalization fuels hyper-inflation, spinning us into a stagflationary death loop that sees Jeremy Corbyn and Boris Johnson re-elected as leaders of extra-radicalized parties that wage running battles in a crumbling Trafalgar Square.”
I’d draw the line several steps before reaching – let alone acting upon – such conclusions.
It’s not that things can’t change radically. (Nor that you shouldn’t have a Plan B, just in case).
Things can definitely change a lot:
- In the 1970s it was hard to get an expensive mortgage to buy a cheap flat in a depopulating London.
- In the 2010s it was easy to get a cheap mortgage to buy an expensive flat in a booming London.
However it’s very difficult to make even short-range economic forecasts accurately.
Massive shifts? Trying to see everything proceeding as you have foreseen – ten years away – is a fool’s errand.
Rather, like judging the weather, it’s usually better to assume more of the same – summer, say, as opposed to winter, or vice-versa – and to focus on the disposition of any clouds on the horizon.
Higher interest rates
What makes doing so tricky this time – and what has roiled markets in 2022 – is that we probably are in a new season.
That’s the regime change bit, right? But I don’t yet see that we’ve fast-forwarded from a balmy June into the depths of a winter solstice.
So far quantitative tightening has mainly been felt in interest rates.
Take the five-year gilt yield as a rough-and-ready driver of rates for fixed-rate mortgages.
The yield on this gilt is back to 2014 levels:
Correspondingly, five-year fixed-rate mortgages have become more expensive.
Tack on 1-1.5% for the bank’s trouble of lending to you rather than Her Majesty’s government and the typical five-year fix is now above 3.5%. (Albeit you can do better if you shop around.)
That’s not too terrible, but some pundits see things getting far worse.
One analyst recently told What Mortgage:
“Given the speed of rate rises this year, as the mortgage market catches up it is not unrealistic to see the average five-year fixed rate at 5% next year.”
This is not an outlandish prediction, though I’d be surprised. While today’s rates are in unfamiliar territory for anyone who has only been saving and borrowing for the past few years, they’re still historically low.
We only have to expand out the view above to 15 years to see the five-year gilt yield above 5% in 2008:
You’ll remember 2008 was the watershed for a little thing called the Great Financial Crisis. Its aftermath saw yields plunge and the start of the quantitative easing that we’re now exiting, via quantitative tightening.
So 5% yields – and maybe 6-7% five-year fixes – are possible if we truly have left behind the great sloshing post-crisis money splurge.
Note though that the market does not currently see 5% as remotely likely, judging by signals such as the yield curve:
Source: Bank of England
Sure, there’s no anticipation of a return to recent ultra-low yields. But there’s no fear of 5% interest rates, either.
Indeed as of the Monetary Policy Committee’s last meeting in June, market pricing for the Bank of England’s Bank Rate was 2.9% by the end of 2022, peaking at 3.3% next year.
Is that a spike in your inflation graph or…?
The elephant in the room is, of course, inflation. High inflation that persists for longer than anticipated could see more interest rate pain inflicted than is currently priced in.
Hardly anybody saw inflation or rates being where they are now, this time last year. So the market is hardly infallible.
And trying not to see high inflation these days is like trying to tell your brain not to think of a pink elephant:
Source: Office for National Statistics
Just this week inflation hit a 40-year high of 9.4% in the UK. It has gone bananas, to use the technical term.
Market predictions for another big rate hike from the BOE hardened on the latest inflation report. However for those of us not trading day-to-day moves in the bond market, higher Bank Rates were already effectively priced in.
The key questions now – which I do not propose addressing in this post – are (1) whether inflation is still a relatively short-term spike, and (2) whether more rate hikes will do much to bring it down anyway.
There’s lots of opinion to digest out there. Call it right and you can be more confident about where mortgage rates will go.
Personally I believe inflation is more likely to be significantly lower in a year or two than higher. I still see most of the inflation as an aftershock of the stop-start pandemic, albeit with additional factors such as fiscal stimulus and war.
More importantly, the market agrees. And for what it’s worth the Bank of England still believes we’ll be back at around 2% inflation in a couple of years:
The rate of inflation is forecast to keep rising this year. But we expect it to slow down next year, and be close to 2% in around two years.
That’s both because the main causes of the current high rate of inflation are not likely to last, and because we have raised interest rates several times over the past few months.
True, I’d take that prediction with a fistful of salt. Both on the grounds of the Bank of England’s wonky forecasting record and because I do not believe that it will do ‘whatever it takes’ to bring inflation back to 2% if it has to.
Given the already surging cost of government borrowing and the likelihood of a deep recession if rates go a lot higher, I suspect the Bank would countenance elevated inflation at, say, 3-4% for a time as more palatable.
Admittedly 3-4% is not in its mandate. But it could probably obfuscate.
What’s more, the two candidates to be our next Prime Minister appear (as best one can tell) to have different views on both balancing the books and monetary policy.
Then there’s also the ongoing friction burn from Brexit – slowing growth and adding to inflation at the margin.
Doing my own stress tests versus higher interest rates
So that’s a snapshot of the scenic features in today’s economic landscape. I concede it’s a cloudy picture. And possibly I have my finger over the lens.
But what does it mean for our mortgages?
I went into detail about stress-testing your mortgage a few weeks ago. We especially focused on rates. Please go back and read it (and the comment thread) if you’ve not done so already.
This rest of this post is the promised follow-up as to how my thinking is evolving around my own controversial mortgage.
My situation is unusual – interest-only mortgage, got it weirdly, self-employed, and (sort-of) financially independent – but hopefully my musings will be food for thought.
Or just plain voyeurism! I mean, it could be a bit of a thriller for viewers.
The fixed-rate term on my mortgage expires in February. That’s unfortunate, given Bank Rate could be peaking shortly thereafter.
With a bit of luck however five-year yields and beyond will already be dropping by then. Albeit perhaps because recession is looking more likely, which may in turn make banks more reluctant to lend cheaply.
Clearly there were easier times to refinance an interest-only mortgage. Such as most of the past four years.
My mortgage: naughty but nice
I got my interest-only mortgage for a variety reasons.
Most obviously, I wanted my own home!
But I also wanted to keep my tax shelters intact, rather than withdraw money from my ISAs to buy a flat mortgage-free. If I’d done that then much of my painstakingly accumulated ISA tax-shield would be lost forever.
I also judged cheap mortgage debt would help ease the pain of any unexpectedly high inflation that emerged from the near-zero rate era.
Inflation erodes the value of debt, in real terms1. All things equal this makes the debt less of a burden over time.
Look at that inflation rate in the chart above. With inflation where it is, I’m currently earning roughly 7% in real terms on my mortgage. That’s incredibly attractive, all things being equal.
But of course all things are rarely equal.
For starters, to benefit from the negative yield I must be able to make my mortgage payments. Running a mortgage that I could otherwise pay off from my investments means assuming a risk that effectively levers up my portfolio.
That is, I am borrowing to invest via my mortgage. And the cost to do so rises with higher interest rates.
This brings up the second aspect. What did I do instead with the money that I could have used to pay off my mortgage?
I have had it invested, mostly in equities.
For the first four years this was a boon. But the wheels have come off this past six months.
I’m still up on where I would have been in cash terms – without adjusting for the extra risk I took by investing and taking on debt – thanks to my gains over the first three and a bit years.
However share prices have been falling for months in 2022 even as higher interest rates make funding their ownership more expensive.
And that means investing via the mortgage doesn’t look like the no-brainer it was as recently as November.
Higher interest rates: fine, within limits
To cap it all, my income from work is severely down over the past 18 months or so.
That was by choice – I sort of drifted into living the financially independent lifestyle. As the market soared in 2021 I stopped renewing my freelance gigs. I didn’t formally decide to quit work.
Why this happened and whether it should have is for another post. The point is I’m tending to think as if I’m living off a sustainable withdrawal rate (SWR) on my assets. Even though in reality I still do have some earnings.
Of course, there’s one huge comfort when running a big portfolio alongside a big mortgage. If you really must you can sell whatever you need from the former to cover the latter.
To my mind this makes what I’m doing pretty safe. I’d certainly prefer it to paying my mortgage with a salary and no savings.
Ideally though, I want the portfolio to continue to grow to meet future demands, FIRE-style. Hence I think of my mortgage payments as coming out of my notional SWR rather than drawing down capital.
- At my current rate of 1.99%, the payments are easily covered by earnings, let alone the portfolio.
- At a rate of 4%, which I judge a good bet for February – up from the 3.5%-ish my bank is touting today – the monthly mortgage payments would still be less than a third of my vague SWR.
- A mortgage rate of 6% does get uncomfortable. Note there’s no immediate danger at all. I could continue for decades at this rate, and the chances are good that withdrawals would be covered by portfolio growth. In that case I’d still grow richer. But ‘probably’ starts to loom larger in the long-run picture.
Obviously I have other living costs besides the mortgage. Even a blogger has got to eat!
But I am presuming I’d revert to my old graduate student lifestyle if I have to – if there’s a long bear market and no income rebound – which is actually plenty swanky for me.
Would investing rather than repayment still be worth it?
The always-contentious issue of having a big interest-only mortgage while investing is tilted by higher interest rates, too.
Regular readers will remember I shared a spreadsheet for calculating the benefits (or otherwise) of investing instead of paying off a mortgage.
We’ve established in the comments over the years that this mostly comes down to personal attitudes.
However there’s no denying the allure of the interest-only mortgage fades as rates rise.
- At a 2% rate, running a £500,000 interest-only mortgage compared to a standard repayment mortgage could deliver an additional £542,000 in net worth after 25 years, assuming 7% returns.
- With a 6% mortgage rate, that (theoretical, not guaranteed) extra gain falls to just £84,000.
This are simplistic sums that ignore inflation, the jagged path of real-world investment returns, and the significantly higher risks of running a mortgage.
On the other hand, 7% returns are much lower than what I’ve achieved over the past ten years (albeit in a bull market!)
The point is that the savaging inflicted by higher interest rates on ballpark returns is clear.
My gut feeling is that at rates much above 4% I’d probably switch to repayment.
Money’s too tight to mention remortgaging
My unusual circumstances – my bank’s CEO initiated my home loan process, remember – make my remortgaging situation potentially tricky.
However I recently spoke to my bank. Its staff confirmed in a worst case I would automatically go on to the standard variable rate.
The agent also claimed I’d be able to switch to a new fixed rate a couple of months before my current term expires – without having to go through that unusual application procedure again.
But I’m still wary. I’m outside the normal Venn diagrams. And the specific employees who sorted my loan have since moved on.
Moreover this agent was not an expert, just a front-line trooper. (The call I made was recorded. I might need that in a push!)
Refinancing is a formality for most people. Even more so now mortgage affordability stress tests have been weakened. But my odd circumstances make it a bigger concern for me than higher interest rates.
The good news is the investment portfolio that backs the repayment of my loan is (for now) still well up since I got the mortgage in 2018. Even after this year’s declines.
Nevertheless in early 2022 I moved much more than I otherwise would into lower-volatility assets:
- I’m trying to increase the odds I will look like a good credit risk to the bank. In my situation that means keeping my net worth up for the remortgaging window in February.
- I want to reduce volatility on a big chunk of my portfolio just in case I want to pay down my loan. Perhaps because rates surge or the bank decides it now has a problem with me.
It may even turn out that moving on to the standard variable rate for a while won’t be my worst option come February.
Plan B if the computer says “no chance”
In general I’d always favour fixing, for the certainty of payments.
But my remortgaging window seems likely to open shortly before an inflection point for rates. It could be worth giving it six months (presuming this doesn’t impair my ability to actually fix again, due to my odd situation.)
What’s more, most fixed-rate mortgages come with restrictions on over-payments. There are none on my bank’s standard variable rate, however. That would enable me to reduce debt – and risk – quickly if I felt wobbly.
If push comes to shove – if I don’t want to make big repayments or I can’t secure a halfway decent fixed-rate residential mortgage – I’ll possibly even switch to a buy-to-let mortgage, turn my flat into an investment property, and spend a few years living abroad.
This might seem dramatic, even for a Plan B.
But remember I’m a single guy and I work from home.
Truthfully I should probably be taking advantage of the whole Digital Nomad opportunity anyway!
Five years a mortgage slave
Finally some psychological and emotional reflections.
One of the more unusual reasons why I got my mortgage was to see how I managed as an active investor carrying a lot of debt.
How would I feel with this potentially deadly obligation on my balance sheet? Could I cope? Would it change how I invested? Would it be worth it?
Well I’ve learned I don’t love it and it’s probably not good for my stock picking.
I was concluding this even before the recent market falls.
For instance I’m pretty sure I wouldn’t have sold Tesla (and various other dumb things I did in 2018) if I wasn’t discombobulated by my then-new mortgage.
And while in theory even a modest return that’s leveraged by an interest-only mortgage can deliver great returns with lower stock market risk, in practice I’m still drawn to riskier growth shares.
This reality also made it easier to shift a large proportion of my assets out of equities entirely and into what I dub my new ‘low volatility’ portfolio in early 2022.
As mentioned it has tamped down the overall volatility in my net worth, as well as making me confident I can make big or even total repayments in February 2023 if I need to.
I’m also happier focusing my now right-sized equity portfolio towards riskier equities with this buffer at my back.
Given this year’s declines, I lucked out with the timing. But if I still feel I need to keep a large slug of safer assets even after I have successfully remortgaged for another five years, say, then it could be a drag on my returns.
It might be a sign I am having emotional trouble scaling my risk profile via the mortgage as I age, as a couple of astute readers have already suggested.
Mathematically, too, a lower expected return portfolio might compare poorly versus simply paying off my debt. Especially given higher interest rates.
Running a mortgage at a rate of less than 2% and investing is a different proposition compared to higher interest rates at 4-6%, as we’ve seen above.
The historical return from shares is only 9-10% remember. The case for investing versus paying off your mortgage is weakened, even if it still makes theoretical sense in a spreadsheet.
My original plan was to run my big mortgage for the full 25 years to take advantage of the return spread and inflation.
But I’m starting to think I’ll probably pay it off sooner than I’d imagined.
I’m in no rush to decide on this, especially now shares are cheaper. Falling share prices increase their expected returns, even absent any stock picking alpha I might rediscover.
However if and when markets recover I may well redirect future spare cash flows towards the mortgage.
I’m only human after all, it seems.
Time will tell. Stick around to see how the story ends!
- That is, inflation-adjusted. [↩]
I have done pretty much the same for the past few years – interest only current account mortgage.
I’ve put as much as possible into my SIPP and left money in my limited company (Now closed thanks to IR35) rather than paying off the mortgage.
Yes I see this as borrowing to invest and it was a deliberate choice, that I’m happy with. Worst comes to worst I could pay off the mortgage by drawing on the SIPP.
I’m only now finally paying off the mortgage as the term ends when I’m 65. I’m fortunate to be able to do this out of income from work.
I paid off my mortgage via overpayments every year up to the limit that avoided overpayment fees. With perfect hindsight, at this time, like you, I would have been better off in terms on overall wealth to have paid the minimal on my repayment mortgage and invested the rest. I also imagine an interest only mortgage would have been better still in terms of net worth, at this time.
I don’t regret my decision. We might be having a different perfect hindsight discussion in 5 or 10 or even 20 years time. This does not mean any of our decisions are incorrect.
Your comments on how the situation might impact your investment decisions are interesting as they are the wealthy form of why struggling people don’t/can’t invest. I am a boring passive index investor but I required a large safety net and a paid off mortgage before I cound even index invest outside of workplace matched pension schemes. Similarly, someone with little spare income and savings may avoid volatile assets even if the expected returns were grossly more favourable with the volatile asset. Maybe in your case locking in a capital repayment mortgage at optimal loan to value over a long period is best? – If you can pay 40% of the value as a capital downpayment you will get likely best rates, and bank risk models and underwriters views (if you need to go through the non automated underwriting route) will likely be favourable as they already have 40% of the property value, and if you default and they repossess in the future, they then would sell and even if they only got partial value, they would likely still be taking no lossess. The banks issue currently with your position is they have NOTHING except the value of the house as security, if they had 20+% of the house capital value already, the risk of repossession and selling to them is much lower as even if you stripped all the pipes, carpets, and trashed the place before being forced out, they would still likely make money on the sale (this scenario is not as uncommon as a reasonable person would hope). Your banks issue is the ‘risk’ of huge financial losses with your current arrangement, as it is very, very high. Them seeing you paying down a mortgage or even being willing to put down a decent capital deposit drastically reduces the perceived and modelled risk (think of what your banks estimate of the lifetime expected losses associated with your current arrangement would look like compared to one associated with them even having even a 10% deposit and the expected monthly paydown curve of a repayment mortgage together with an estimate of the expected sale value of your house minus any eviction/legal costs and bringing the house back to a minimal standard).
Or, move to a cheaper area and be closer to being fully early retirement. There are brand new build 4 bedroom houses in various parts of the country at ~£350k, small houses cheaper again. I do think this blog and many of the readers are heavily influenced by all the london chat and costs. Yes, if family, friends, work and interests are all in your area then you probably don’t want to leave over money unless you are forced to, but from reading your posts I have a feeling a dent of £250k-350k, or the same as a repayment mortgage over 10 years would not be a substantial hit to your overall wealth. As a hypothetical exercise, it might be worth going back to basics and asking what do you need housing wise and can you do it much cheaper somewhere else in the country whilst still being able to do the other things that matter to you?
If real FIRE is the aim, the where part of your living arrangements is not fixed, certainly not in the phase where you are fully RE.
If you are in the last year of a sub 2% I/O mortgage, why didn’t you just secure a new deal within the last year when 10Y fixes were available around 1.74 – 1.89%. Even if you weren’t certain, you could just sit it out for 6 months to decide whether it was for you or not. I’m sure paying the final year ERC worst case would have been a pretty small sum to gain another 10Y sub 2%?
@wildFIRE — As I keep trying to stress and link to — but appreciate few people follow the links — there is currently one bank in the world that will give me a mortgage on the terms that enabled me to buy a flat I wanted in London with sufficient size to avoid me having to liquidate most of my ISAs — and I only got the mortgage because I wrote to the CEO…
Everything is different if I’m a normal punter shopping around, absolutely. That was why I quarantined my own situation to the last quarter of these two posts. 🙂
@Random coder — I’m currently at about 30% equity in the property, assuming zero price movement over the past four and a bit years, which I think is prudent. I agree at some point I’d like to switch to a repayment mortgage. I love London. But I love the countryside too. It’s been many years since I was in London for the jobs specifically. I have a feeling if I can’t roll onto something suitable in February it might be keep the flat and get a job or sell up (/rent out) and do something more Bohemian instead.
PC — I have mixed feelings about paying off a mortgage just due to age IF you’re a single person with no dependents. If you have those (or you want to leave a legacy) then absolutely I’d prefer to pay off at your stage. Congrats on winning the game! 🙂
I’m in a similar situation, but on a smaller scale.
In 2008, apparently before the banks realised they were f*cked and tightened the screws on lending, I remortgaged to a lifetime tracker (base rate +0.74%) on an interest-only basis. With hindsight, what a great decision.
I FIRE’d five years ago and cover my costs, including servicing the mortgage debt, from my investments.
Now that interest rates are rising, and the return on investments is not matching inflation, the equation becomes less clear-cut. If the markets pick up again in a couple of years and inflation falls back, then everything will be rosy, but if the current trend continues then I would need to consider whether to take action with the mortgage.
Thankfully, my mortgage will be a lot smaller than TI’s, and I also have a large chunk of equity in the property, as well as the mortgage allowing unlimited over-payments, including clearing it early, should I desire.
I did similar to you but a 3 – 4 years behind you, therefore I took my offset mortgage at BOE +1.74%> I remortgaged last summer, just extended the term back to 25 years at 60% LTV but didn’t release any cash. However, with one eye to the future, earlier this year I also secured a 10Y fix rate at 1.89% / 60% LTV and including a plan to release 50k cash to invest in S&S ISA or another BTL, both ideally in a crash environment ha!
I sat on the offer for 4 months, but as interest rates have continued to rise, I’ve decided to take the new mortgage to fix my payments and release the cash. I’m going to be really sad to give up my offset mortgage, but I just couldn’t bear to be paying double or triple the amount of interest I needed to. I’d rather release some cash now for any opportunities and have more to invest each month. Sounds like you have a bit more breathing room than me with BOE +0.74%!
> I didn’t formally decide to quit work.
I am glad to see that Hell hasn’t frozen over yet. There’s war in Europe, a likely incipient energy crunch and recession on the way and out fellow citizens are increasingly destitute, but the day TI retires to some Swiss mountain fastness will be the day there are horsemen galloping from all points 😉
Couple of points. The long term historical interest rates for the UK are about 6-7%. Sounds like you could handle that – most of my mortgage payment history across 20 years was at that sort of level, though I did see > 14% in one year. The anomaly is more the post-GFC period, which as you say is coming to an end – all those cans kicked down the road are now a wall right across it. But I would say reversion to the mean points to 6% or so, although the volatility has been shockingly higher in the past.
> turn my flat into an investment property, and spend a few years living abroad.
Do you have Irish descent or some other way of repossessing your EU citizenship to enable you to do this, or are you going to keep the income on the QT 😉 I guess there are ways and means further afield, in return for less political stability. Though that’s a moot point I guess as the UK could change with the increasing destitution of more of the population…
You will probably need to stay with bespoke solutions. I have had the experience of being a civilian enquiring for a mortgage, with one fully paid off house and ISA + cash enough to buy the new house outright – I wanted to use it as a bridging loan but without the outrageous rates for bridging loans. But I had a income that made me look poor. After two mortgage brokers couldn’t get rid of me fast enough, like I was a bum stinking the joint up, I abandoned that approach. It seems banks in the UK are of the belief that everybody pays their mortgage down from their income, and reasons like preserving an ISA allowance make no sense.
Odd really, I am sure that back in the day there used to be PEP and later ISA mortgages, when endowments were shown to be ghastly. These were IO mortgages where a shares ISA was built up as the capital repayment component and pretty much exactly what you are doing, but I haven’t seen them since the GFC, presumably when we discovered many IO mortgagees seemed blissfully unaware of the fact that their cheap mortgages weren’t buying the capital cost of the house, and the papers had sob stories of people ‘suddenly’ discovering this inconvenient truth in their 50s.
My basic feeling is the conservative party membership like Truss.
Truss will cut taxes because she will always follow the base and does not lead it.
Interest rates will have to go higher than current predictions as a result.
SVRs are usually 200 bps above base rates, so you could well see a 6% interest rate from a challenger bank bleeding bad loans.
As far as I can tell you owe half a million on a 800k flat with a basic rate only income, maybe you should shell out for a mortgage broker and fix?
Great article – but one point I’d raise is that you’d only be “refinancing” if you were changing provider / taking more cash out – if you’d gone for a 25 year mortgage with a 5 year fix then you’re simply asking for a new fix but it’s still the same mortgage so you shouldn’t have to go through an application process.
You can usually change to a new deal (depending on provider) a few months ahead of your deal expiring. I did this with Natwest last week for a mortgage expiring end of Nov and paperwork etc has all completed in a couple of days.
I’m not as confident about inflation declining in the near future. It doubtless began due to the stop-start pandemic response, but now it looks like inflation because inflation. Why is my rent increasing by 15% next month when the property is financed at a (US) fixed rate? Because inflation.
Beginning to think only a recession will put an end to it, and is thus inevitable.
PS: put me in the financial voyeurism camp. Recording phone calls with the bank for leverage down the road – love it!
Interesting as always, I have borrowed to invest via a mortgage, it worked out ok but not as great as I expected at the time…events occur, unexpectedly.
It feels more comfortable not to borrow as we age, mainly because it becomes unnecessary, you’re seeking to take risks you don’t need to, for gains that you fundamentally don’t need.
@Ermine trying to borrow money when you are asset rich, income poor is not good. It is frustrating and my attempts to avoid a bridging loan were equally unsuccessful in 2019. ( I could have paid for the new property 5 times over…)
I think an important thing to remember is that the I in FIRE is independence. If you’re at the whim of a landlord, market rents or market interest rates, are you really independent?
Having the *option* of repaying is definitely a form of independence though. I mean, with a mortgage of almost 5x gross income I’m not expecting to be in that position until I’m 60.
Re this post and and the comments I made on your post back in Feb 2020 that on average it should work out OK. Or, put another way, it worked until it stopped working!
Your next steps are tricky and I would be especially wary of comments made to you about your renewal options – even if you have them recorded and/or in writing! By way of an example, IIRC, @weenie was given similar re-assurances which turned out to be totally worthless when it came down to doing the paperwork.
As you say, you still have options.
IMO it might be worth exploring if you can accelerate your renewal?
> I mean, with a mortgage of almost 5x gross income I’m not expecting to be in that position until I’m 60.
Hmm, don’t be so sure. My late twenties younger self was stupid enough* to pay 4.5 times salary from a house in the late 1980s.
Twenty years and another house later my older and hopefully wiser more grizzled self discharged the capital, and that was after a year of paying down about £6 a month on the residual £1k of my offset mortgage, I could have cleared it after 19 years. You will have had the benefit of some heady inflation early in your mortgage life, which will greatly depreciate the real value of the capital sum, something I didn’t have. I also got to eat the privilege of paying nearly 15% interest rate in my third mortgage year…
* stupid at that time. I am nowhere near clever enough to say whether that would be stupid now, given there has been a decade of incontinent lending to all and sundry. Colleagues and my parents suggested the Torschluss panik of couples trying to grab double MIRAS might mean this will change, but I was young and foolish and had left London because I couldn’t buy a house and thought prices would grow into the sky.
@PC IR35 is over 25 years old now (you make it sound like a recent event). I remember it’s invention well as I was a freelancer at the time and it cost me an arm and a leg in extra tax.
Very interesting reading.
I remember back in the day being on a Northern Rock tracker at Base +0.25% with no floor. 2008 was music to my ears. I was put in the “Bad Bank” because they couldn’t offload me to one of the purchasers of the mortgage debt. I then, to raise capital, put it in an offset mortgage where I doubled my mortgage to fund a business. I just couldn’t do it without the loan and the tracker suddenly went to Base +1.8% with a floor – sad I know! It ended up changing from about £225 per month in interest to approx £1200. 5 years or 60 months later I still think it was worth it.
Anyway inflation is awful – I’m in the property development game – and about 2 months ago old copper and steel were commanding £6900 and £260 per tonne respectively. 2 weeks ago scrap copper and steel was at 5250 and 140 per tonne. Big difference – they always say scrap copper price is the canary in the coalmine for the building trade, but I can’t see Inflation choking off with everyone wanting 10% pay rises – we are at risk of a spiral and most of it’s global so out of our control. By the way with oil now at $95 a barrell, and last time it was there at the beginning of April Diesel was at £1.60 and we’re still at £1.95 it appears a fair bit of price manipulation at the refineries. Of course the government have literally shut up shop (not making meetings, taking jet flights, etc – I mean Eurofighter jets!) till September 5th so nothing will be done about it.
If you pay off some of the mortgage, your equity in the property will increase. You can consider it as ballast in your portfolio – like the bonds in a 60:40 – and then focus more on equities or riskier assets in your ISAs.
Reducing or paying off a mortgage does wonders for your peace of mind.
I am in a similar position with renewal in December. Should I opt for a 2, 5 or 10 year fix is my dilemma. The question is whether rates will come down again after this jump in inflation but taking a step back these levels are still historically low. I’m leaning towards the 10 year. I am fighting the urge to be defensive in my investing and have instead stuck with a global equities index portfolio because that’s where the long term outperformance has historically been found. Fortune favours the brave….
@Warren I have agonised over this myself the past few weeks. In the end I took the plunge on a 10yr fix simply for peace of mind and budgeting (family of four and I’m the only earner). In the space of 10 days the 5 year rate my provider offered me went from 2.9% to 3.24%.
I was due to renew in November 2023 so I swallowed a 7k early repayment charge and fixed at 3.09% (my old rate was 1.95%). This rate gives a £200/month increase in payments. If you take into account the early repayment fee it becomes the equivalent of around 3.54% based on my current loan value. Only time will tell if I’ve made a mistake but the uncertainty of what future payments could be was what I was uncomfortable with. I’m clearly not a risk taker! The classic worry is that after a few years rates drop and I lose out in a big way…
Isn’t it a characteristic of an active investor that they constantly revisit previous decisions ? A mortgage by it’s nature is a long term thing and similarly aren’t we told that equity holdings ( well at least the asset allocation bit) should be viewed over a timeframe not less than 5 years ?
There is an emotional dimension to debt and who wouldn’t breathe more freely without it ( irrespective of what a financial optimisation spreadsheet might say). Can’t say I understand how anyone could claim financial independence if there is an outstanding mortgage obligation even if the cash flow model says no problem.
Being financially independent and feeling independent might not be the same thing.
Paying down a mortgage seems a reasonable diversification strategy to me, financially and emotionally. Since you use cash to pay down a cash debt that seems neutral in terms of asset allocation. If you use the cash to leverage your equity position instead and get into fortune telling on the comparative returns from equities and house prices with inflation and interest rates as parameters, with an active investor mindset won’t the worms keep gnawing at your brain ?
Ermine beat me to it on the living abroad thing – tax (you’d lose your ISA coverage that way?), post–Brexit visas, how to get beyond Kent…
I used to think I might one day “drift” into semi-retirement – just do less work. But if you’re self-employed, it does raise some issues. You decide you don’t want/need the work. Your clients get that message. They go elsewhere. It might take a while to reverse that as and when you decide you do want/need to do some work again.
Do mortgage rates have to fall lockstep with risk free interest rates falling? Certainly not. Surely mortgage rates have to incorporate risk as well as costs in doing business. With higher cost of capital in general, how much of this explains the rise in mortgage rates?
We might well find inflation fall and thus interest rates fall, but will risk have also fallen by similar magnitudes? Arguably we might be entering into a regime of increased economic uncertainty despite any potential falls in inflation. Might that keep mortgage rates stubbornly high?
After all, lenders are private businesses and are incentivized from a profit perspective whilst also capital restrained.
I suspect I’m unusual in seeing debt as just a business balance sheet thing – if I can borrow for less than I can earn, then debt makes sense – with appropriate adjustments for tax and risk.
I am probably at the extreme other end of the spectrum here – couldnt wait to pay off mortgage (while maxing out on pension contributions at the same time of course). Great relief when it was paid off. No amount of numbers and weighing up of investment risks would have altered my course. For some its an emotional thing, perhaps based on what satisfies the need for financial security and greater certainty.
If I had my time again, I would probably do interest only to start with, but then gradually increase the monthly payments to match inflation and/or pay rises – as it seems a bit strange that most mortgage products are designed to have fixed payments over the whole term. This means effectively in real terms you pay more when you are first starting out and potentially less wealthy, with payments in real terms reducing as you get more wealthy.
PS/ I personally did something like this with my mortgage – I started with a 25 year repayment mortgage. Every year I increased the payments in line with pay rises, plus also paid off a few lump sums from share options. In the end it was paid off in about 5 years.
> tax (you’d lose your ISA coverage that way?)
The ISA situation for non-doms isn’t quite as bad as that – you can’t put any more into it but it can be preserved and not incur UK tax in the usual way so TI would be OK there, with the limitation of no new contributions..
What he would have to watch out for, however, is how his new country of residence views foreign assets, because a UK ISA doesn’t shelter you from foreign wealth taxes. Or even foreign income on investments taxes, and the income could reduce the available personal allowance if they lump it in with earned income – other countries have a different view of what counts for that.
Hang about guys and girls! 🙂
Thanks for all the thoughts and feedback (great discussion as so often on Monevator) but regarding myself, I’m not necessarily saying Plan C (D/E) would be permanent emigration — more the roaming the world for 24-36 month option beloved of so many blog owners the world over.
My flat would cashflow positive at about £10K a year, ignoring maintenance set-aside. Then there’s my (much smaller) income which would be ongoing, and if need be the portfolio (which preferably I wouldn’t touch).
Back of the napkin maths suggests I could well be better off on-the-road, presuming I avoided New York, Tokyo, and the like. 🙂
As for my longer-term options, as alluded to before I do have some. (Leaving aside my particulars, everyone does if they’ve got money, despite the supposedly anti-elitist Brexit, and you don’t have to decamp to Panama or Vietnam. See Portugal’s golden visa scheme, for instance).
But regarding my comments in the article, I’m more thinking I’d roll around for a couple of years and thanks to portfolio growth (touch wood) probably come back richer, still a London property owner, and ready to reconsider my options.
I’m very much a creature of habit though, which is more what makes it unlikely than the financial regulations of far-flung climes.
I expect a short term drop in inflation followed by a bit of a delayed wage price spiral – next April benefits will uprate with inflation, so the labour market will get even tighter unless wages at the bottom rise again, because it’ll be harder to convince people to work if benefits start paying more, gov support considered too
I wouldn’t rush to pay the mortgage down unless for safety because even the higher rates are not even compensation for the value it’s losing. I expect companies will yield better going forward.
Truss’s tax cuts would hopefully deal with inflation better, since it’s a supply shortage rather than an excess of demand -at the moment-, we need to improve our supply chains
I’m struggling with the decision whether to pay off my mortgage too. There is a relatively small amount owing, both in nominal terms and in loan to value terms (probably less than 5%). And in a few months I expect to get my share of the proceeds of my father’s house in France, which should (depending on exchange rates) pay off the loan with a bit left over. Part of me thinks life would be simpler if I just pay it off -the payment (interest and capital) is about a third of our day to day monthly spend, and I’ve just retired. On the other hand it’s on a lifetime tracker at base plus 0.27% , so even if base rates increase to 3 or 4%. I have a reasonable prospect of making a higher return by investing the cash. Decisions, decisions…
I’ve had a io mortgage since 2017 and broke a 10 year fix in October last year to change to a 5 year fix of 0.99% .
Currently throwing everything I can at my isa after a decent pension contribution. With a recent inheritance forthcoming I’ll be ‘ mortgage free on paper but happy to sit tight for 5 years and see how the land lies. I’m going to keep probably 30k in premium bonds 20k in cash for short term spending and the other 100k I’ll split between isas gia account and possibly boost my partners much smaller pension by 20k.
Happy to roll the dice I’ll be back in 5years to give an update 🙂