Franz Kafka’s classic The Metamorphosis sees the central character go to bed a man and wake up as a giant cockroach. Does your mortgage risk a similar transformation in 2022?

Could this engine of wealth creation become a millstone?

It sounds heretical. For more a decade it’s been almost daft not to run a cheap mortgage.

Barely there interest rates made for affordable repayments. Ever-higher house prices and stock markets meant owning additional assets was more rewarding than repaying your debt.

But now rates are rising. Stock markets have crashed, and house price growth is slowing.

Recession talk is in the air.

Sky-high inflation has driven a regime change. Low inflation and near-zero interest rates have given way to expectations of dearer money in the future.

The shift has already hit the highly-rated growth stocks inside your index fund.

But mortgage risk is a bigger existential threat to most of us than wobbly stock markets.

Why your mortgage matters so much

With about eight months to go until my own five-year fixed-rate mortgage ends, I’ve been thinking a lot about mortgage risk.

Having a big mortgage on your personal balance sheet dramatically shifts your financial posture.

And as a lifelong debt-hater, I’ve found having a mortgage challenging at times.

As I told friends who’ve been mortgaged since their mid-20s – and who couldn’t see what I was fussing about – getting a mortgage changes everything.

Because it’s really hard to go bankrupt if you’re not in debt. You can usually alter your circumstances to match your income. The Micawber Principle holds.

Sure we can all imagine scenarios where everything goes to zero and you end up under Waterloo Bridge. But absent debt, a lot must go wrong for that to happen.

With a mortgage though, things are different.

For starters it’s not hard to find yourself with a negative net worth. First-time buyers who put all their savings into buying a home with a 95% mortgage, for instance, are in the red if their house falls in value by just 5%. (Dragging them into ‘negative equity’.)

Bigger price falls might offset ISA and pension savings, putting even wealthier mortgage holders in the hole.

This certainly isn’t fatal in itself.

Crucially, a mortgage is not marked-to-market. As long as you make your monthly payments you’re okay – even if house price falls mean that you’re technically underwater until markets recover.

But what if you lose your job, or there’s some other financial disaster?

You could then struggle to keep up with your mortgage. Especially if mortgage costs are rising as rates climb.

In the worst case the bank repossesses and sells your home, you’re on your uppers – and you still owe the lender whatever is left of your mortgage debt.

Around 345,000 homes were repossessed in the 1990s housing crash.

That’s the nightmare scenario.

Assess your mortgage risk before it matters

I don’t want to overdo this. Interest rates are still low by historical standards, and employment high. And there’s no indication of a house price crash, except for property’s perennial expensiveness.

Personally I’m still mostly happy running my big interest-only mortgage.

I’ve plenty of assets, despite recent market falls. And I can handle a fair few rate rises.

I expect the majority of mortgaged Monevator readers feel the same.

You’ll typically have emergency funds, other investments, jobs, and you didn’t overstretch to buy.

However we’re all at different stages of our financial lives. Some readers will be edge cases.

Besides, the time to prepare is always before a disaster actually strikes.

Complacency kills!

A checklist to assess your mortgage risk

My interest-only mortgage is backed by my investment portfolio, rather than my salary.

And I didn’t get my mortgage like you got your mortgage. (It was personally arranged).

The whole shebang is very different. This means I must consider several moving parts – and different risks – when evaluating my mortgage-related moves.

You can probably do a simpler sanity check. But I think you’ll still find food for thought below.

Let’s get started.

Re-financing risk: what happens when your mortgage deal expires?

For most readers, this is a formality. Provided you’ve still got your job and nothing dramatic has changed, it should be straightforward to get a new mortgage deal when your current one ends.

Remember your initial mortgage was for 25 years or more. Any fixed-rate term of, say, five years was a special bonus period. Your contract runs for 25 years.

This is a good thing. It means that if you don’t get a new special deal, you should just go on to your lender’s standard variable rate (SVR). So you won’t suddenly need to repay your mortgage.

But what you probably want is a new bonus offer.

Let’s say you come to the end of your fixed-rate period. You should probably look to remortgage on a new fix, or some other kind of special rate. This will likely be cheaper than staying on the SVR.

Your best deal could be with your current bank, or with a different lender.

Sitting pretty with higher equity

Your status as a borrower has probably improved since your last mortgage deal.

UK house prices have been rising. This likely applies to your home, too.

You’ve probably also paid off some of the mortgage balance, alongside the interest.

Combined, this means you should have more equity in your home. (Equity is what’s left when you subtract your outstanding mortgage from the value of your property).

More equity usually means access to better rates.

Before, you might have been in the 90% loan-to-value (LTV) mortgage category. But perhaps your greater equity now puts you in the 80% bracket.

Banks will offer you a lower rate compared to somebody with less equity. Lending you money has become less risky. There is a bigger equity buffer against house price falls.

Remember this is mostly helpful for the bank because it protects its loan if it has to repossess your property and sell it. You obviously don’t want it to come to that!

When remortgaging you’ll also have a – hopefully clean – history of making mortgage payments. No longer are you a highly-stretched young schmuck without a track record. That will further increase your appeal to lenders, compared to when you were a first-time buyer.

So shop around.

Look out for early repayment charges: Most mortgage deals come with a penalty charge for early repayment of the mortgage for as long as the deal lasts. For instance I faced a 5% penalty in the first year of my five-year term, falling to 1% in the final year. However I can pay off 20% of my outstanding balance every year without penalty. Check your small print. Also: sometimes it may be worth paying a penalty charge to secure a new mortgage deal at a lower rate.

What if you lost your job?

If there’s been a big change in your circumstances you may struggle to get a new mortgage deal.

That’s because you could be asked to prove your income and other details such as credit card debt as part of your application for the new deal, just like when you first got your mortgage.

However at worst you should just revert to continuing on your lender’s standard variable rate. Your home ownership is not immediately at threat.

The downside is the SVR is probably costlier than with a deal. You’re also exposed to future mortgage rate rises (or cuts).

I’d suggest it’s nearly always better to lock in a fixed-rate mortgage when you can.

Even if you believe interest rates might not rise much more – or fall – the security of having a fixed schedule of mortgage payments is valuable.

Not sure where you’ll stand when your current deal ends? Give your bank a call so you can prepare.

Repayment risk: keeping up as mortgage rates rise

However you refinance your mortgage, you may well have to pay more each month because mortgage rates have been rising.

To state the obvious: higher mortgage rates mean higher monthly payments.

Can you cope? Do your sums to see if you should already be rethinking your budget.

I covered stress testing your mortgage against rates rise in my last post.

Please read that if you haven’t. Rising rates is the biggest mortgage risk for most people.

Interestingly, however, there’s been a development since my last article.

The Bank of England has told lenders they no longer have to stress test borrowers to check they could afford to pay with much higher mortgage rates. The central bank believes that restrictions on loan sizes as a multiple of income will be sufficient to keep things under control.

Maybe so, but it seems a curious decision just when rates are rising. If the Bank wasn’t politically independent you’d smell a rat.

With respect to today’s topic though, this shift might make it easier for some people to remortgage in a pinch.

Remember, the high inflation ushering in higher rates is also eroding the real value of your outstanding mortgage. That is definitely a good thing.

However you need to keep up with your mortgage payments to benefit.

Repossession in an economic downturn is to be avoided at all costs.

House price crash risk

This brings me onto the potential for house prices to fall.

Lower house prices is not a direct mortgage risk.

Unlike with a margin loan with a stock broker, for instance, your bank does not constantly reassess the value of your home and demand more cash if your equity falls below a critical threshold.

That’s one reason why a mortgage a relative safe kind of personal debt.

The other reason – for you and your lender – is a mortgage is secured against your property.

This asset-backing is why you can borrow to buy a home at 3.5%, but credit card debt costs 25%.

But it’s also why falling house prices are a tangential mortgage risk.

If lower property prices mean the equity in your home has fallen when you remortgage, you could have to agree a more expensive deal.

And if you’re in negative equity you could end up stuck on your lender’s SVR.

Buy high, sell low

And what if you need to sell your home when house prices are down?

At best you’ll lose out because you have less equity in your home to get as cash after the mortgage is paid off.

At worst, your house sale won’t cover the mortgage. You’ll be in arrears.

Unlike in some countries – and several states in the US – you can’t walk away from this debt in the UK. You’re still liable for the shortfall, even though you’re no longer a homeowner.

There are rules, though. If it happens you’ll definitely want to seek advice.

And banks really don’t want to go down this road. It is expensive, and bad for publicity. They will usually try to agree some new payment schedule.

We can’t be sure that would happen in a really deep downturn, though.

Keep up your payments and you’ll be okay. But this is a mortgage risk, hence I list it here.

(Further) stock market crash risk

Fewer Monevator readers will need to worry about lower share prices with respect to their mortgage.

Indeed for most people in the accumulation phase of life, a stock market crash – and the chance to buy shares cheaper – is a good thing.

But if, like me, you’re on an interest-only mortgage that’s meant to be paid off by investment returns – or maybe you’ve still got a market-linked endowment mortgage from the 1990s – a drawdown in your portfolio could matter:

• In the short-term, there’s the risk your portfolio falls a lot and at the same time your bank checks on whether your repayment vehicle is on-track. You can chant ‘be greedy when others are fearful’ to bankers all you like – they will only lend you an umbrella when it’s sunny. Banks will be spooked by a portfolio decline. This will probably limit your options if you want to agree a new deal – perhaps to address a projected shortfall – such as extending the mortgage term.

• In the long-term, there’s a danger that your future investment returns leave the portfolio unable to cover the mortgage. In my case this would require negative nominal returns over the next 20 years! Not impossible, but I judge it to be low risk. You’ll have to do your own sums.

As I said, borrowers with endowment mortgages from the ’80s and ’90s have already trod this ground.

At one point there was lots of talk of an endowment shortfall crisis in the UK, and of how this might also encompass struggling interest-only mortgagees.

We don’t hear much about it now. Products and strategies were created to help usher older mortgagees over the line, and I expect many just sold into a stronger market and downsized.

The bottom line is anyone reading Monevator with an interest-only mortgage should be on top of their finances. Don’t assume another decade of high returns like the last one will bail you out. Contribute more money to your investments, or consider doing something else like shifting to a repayment mortgage or even selling up while house prices are strong.

Personal risks: health, job, moment of madness

Finally a broad catch-all covering all kinds of developments in your personal life.

Clearly if I could forecast whether you’ll be hit by a bus or suffer a stroke, I wouldn’t be writing a financial website.

However some kinds of massive disruption are predictable – and yet you might not have associated them with your mortgage before.

For example I’ve known couples set to divorce who’ve put off (un)doing the deed for years. This could be a big mistake if you find yourself having to divvy up a house in the midst of a house price crash, or if the main breadwinner is made unable to meet the payments.

Or perhaps you’ve known health problems that will eventually see you leave work, but you’re soldiering on for now? From the perspective of your mortgage it may be better to bite the bullet and downsize to get mortgage risk off the table, to avoid being hit by a double-whammy in the future.

I also think it’s fair to say the risks of running a mortgage increase with age – although there comes a point where it’s more your bank’s problem than yours!

The inescapable truth is a healthy young 30-year old has more time to correct missteps than a 60-something near-retiree. Act accordingly.

Be prepared

Given the shifting financial landscape, I believe it’s a good time for everyone to think about mortgage risk – and any upcoming remortgaging plans – and to consider what could go wrong.

Channel your inner Chicken Little. Imagine the sky is falling.

Could you be squished like a chicken nugget?

Let us know in the comments below.

In a couple of weeks I’ll return to my own mortgage, and give an update as to where I’m at as a result of all this thinking. Subscribe to make sure you see it.

Investing is a swampland of hidden costs, semi-hidden costs smeared with camo paint, and costs hiding in plain sight shouting “I’M A COST” – but, alas, everyone’s too exhausted by the world to pay any attention. FX fees (foreign exchange charges) are of the semi-hidden variety.

FX fees are invariably buried deep in your broker’s Costs & Charges pages. They occasionally turn up in your transaction history but as often or not just aren’t mentioned – like an embarrassing uncle who exposed himself to the neighbour’s budgie.

The issue is FX fees are not only charged when you trade international shares or if you like to pick ‘n’ mix FOREX1 funds. 

You may well find a slice of your income lopped off every time your apparently bog standard global or US or emerging market ETF pays dividends. 

And some brokers charge a ridiculously high amount for FX conversion, making like a wealth mosquito that won’t quit harassing its favourite cash cow.

But there’s good news! You can squish FX charges.

Some brokers offer very competitive currency conversion rates. Moreover you can cut FX fees out completely by choosing the right ETF.

When are FX fees charged?

There are two main instances:

• When you trade in an ETF, fund, share, or other instrument that isn’t priced in sterling. 
• When you receive dividends in a foreign currency. 

In both cases, your broker will convert your money into the appropriate currency and take its cut. 

Sounds fair – except that like a currency exchange machine in a hotel lobby, your platform may not be incentivised to give you the best rates. 

How can I avoid FX fees on dividends?

This is easily done with ETFs by choosing the accumulation version of the fund. 

The accumulation variety of an ETF automatically reinvests your dividends back into the fund for you. 

Because the dividends aren’t paid into your broker’s account, you don’t incur FX fees. 

However ETF providers aren’t always great at listing the accumulating versions of their ETFs.

I mean, why make it too easy?

Vanguard is particularly bad at this. The company’s consumer-facing site typically lists the distributing versions of its ETF range. 

The simplest way I’ve found to uncover accumulating ETFs is via justETF’s Screener page:

Drop the name of your ETF into the search bar.

It’ll list all the ETFs different incarnations. (They are all clones in terms of what they hold, so don’t worry that there’s any intrinsic inequality between versions.)

You can usually tell how each version treats dividends by scanning the variations in the fund name.

It’ll be an accumulating ETF if its name contains any of the following abbreviations:

• Acc
• A
• C
• Cap

Whereas the ETF pays out dividends to your broker if its name is tagged with any of these tell-tales:

• Inc
• D
• Dis
• Dist

Sometimes an ETF’s name refuses to divulge its secrets. In that case click on the screener’s Use Of Profit filter on the left-hand side of the page. Choose the Accumulating option and you’re away. 

See our fund names explained post for more on decoding index trackers. 

How can I avoid FX fees on trades?

You can dodge FX fees on trades if you choose an ETF that’s priced in pounds on the London Stock Exchange. 

This time it’s not as simple as checking an ETF’s name to see whether it mentions GBP. 

For example, Vanguard’s FTSE All-World UCITS ETF (USD) Accumulating trades in both:

• US dollars – using the ticker VWRA 
• Pounds – via ticker VWRP

Choose VWRP to trade in pounds and so skip foreign currency conversion costs.

To discover which currencies an ETF trades in, go to the London Stock Exchange’s home page.

Put your ETF’s name in the search box top-right.

If the search box waterfalls a list of candidates then tap on Show all instruments.

Each ETF’s trading currency is listed in its entry on the Instrument page. See the red circles in the pic below:

If you’re not sure, then click through to the ETF’s page and check the currency listed in the ‘Last 5 trades’ section. That will confirm whether it trades in GBP, USD, or whatever.

To completely eliminate FX fees, choose an accumulating ETF that’s priced in pounds on the exchange. 

That’s because a distributing ETF that trades in pounds can still pay dividends in foreign currency. 

Explain!  

A fund’s currency status can be confusing:

Underlying currency – this is the currency in which the fund’s holdings are traded. If you hold a S&P 500 ETF then the underlying currency is US dollars – because it holds US shares. Whereas a FTSE 100 ETF’s underlying currency is pounds – it owns British shares. An All-World ETF has multiple underlying currencies because it trades in securities priced in dollars, euros, yen, baht… 

This currency classification determines the nature of your currency risk. You are exposed to the pound’s exchange rate, versus every currency that the fund’s underlying securities are traded in.

Base currency – this is the currency a fund reports its Net Asset Value (NAV) in. It distributes its dividends in this currency, too.

The ‘USD’ in Vanguard FTSE Emerging Markets UCITS ETF (USD) label tells you its base currency but nothing else. You aren’t exposed to currency risk against the dollar because it doesn’t invest in dollar-traded equities. Base currency may also be called denominated currency or fund currency. 

Trading currency – the currency in which a fund is bought and sold. Most ETFs will be available in a pound-priced variety on the London Stock Exchange. 

Currency hedged – This is how you protect yourself from currency risk. If an ETF is GBP-hedged then it uses a financial instrument (such as a currency swap) to neutralise the effect of exchange rate fluctuations on your investment return.

Look out for the term GBP hedged in an ETF’s name or its documentation. 

How can I avoid broker FX charges entirely?

You can avoid egregious FX fees by first finding a platform that enables you to hold foreign currency in your account with them. Then you can convert your currency using a more competitive service that will transfer your overseas readies to your investment account. 

Good currency brokers should be able to beat your stockbroker or bank’s transaction costs as comfortably as Usain Bolt could beat me at the 100m. 

But it’s worth knowing that you can’t even hold foreign currency in a Stocks & Shares ISA.

You can hold foreign currency in a SIPP. But your cash contributions must be made in pounds. 

It’s probably less hassle just to choose a broker with a competitive currency conversion fee.

How bad can broker currency exchange fees be?

The worst rate I’ve seen is 1.5% on top of the spot rate (that is, whatever the market is offering at the time on the pound versus foreign cash). 

Generally 0.5% or less is about as good as it gets for a platform aimed at regular Jo/Joes. 

Some specialist share dealing brokers offer rates at a tiny fraction over the spot price. 

But these are typically aimed at semi-pros. They may encourage portfolio churn, and there can be other charges such as non-fixed trading fees.

Such complex platforms don’t hold your hand. They’re suitable for the extremely confident and disciplined only. 

Fish in the Zero commission platform table of our broker comparison page if you want to optimise FX fees. 

Final warning

Beware: some brokers make it very difficult to uncover their actual currency exchange fees. 

Either they neglect to mention them. Or force you to spelunk their T&Cs to find them. Or they pop a little table on their fees page but make you read their Foreign Exchange FAQs to find out their cut is on top of the spot rate. 

Be careful out there. 

Take it steady,

The Accumulator

1. Foreign exchange. [↩]

What caught my eye this week.

Another roughhousing in the markets. It’s enough to make you wish you’d pursued a gentler hobby. Maybe kickboxing.

The falls are now officially deep. Even British investors tracking their global returns in our ever-punier pounds have taken a foot to the face:

Presumably I won’t get readers telling me this time that I’m being spooked by phantom bears. Because the pain is finally spreading to all corners.

Okay, bully for you if you had more than my few percent in gold.

Indeed more growth-minded investors like me are frantically tapping the mat like we’re trying to drive nails into the ring with our bloodied hands.

Meanwhile I doubt there’s a professional developed market bond manager in business who has seen a market as bad as the past six months. (Apologies to any septuagenarian fixed income experts reading.)

Even value investors have not been unscathed. Lately they’ve found a puck coming in their direction can still smack them in the face. The cheap and stodgy FTSE 100 threw in the towel this week. It is now down nearly 7% for the year.

You’d still rather have been in value than growth of course, if you’re a naughty active sort.

The UK’s largest, growthiest – and until recently frothiest – investment trust Scottish Mortgage has fallen 46% year-to-date.

Warrior

Old hands might be expecting it’s around now that my gung-ho alter-ego will enter the ring, raise his fists, and urge that it’s a great time to buy – like in March of 2009 or 2020.

It could be. It’s certainly hard to imagine (non-UK) investors being much more bearish.

Alas Alter-Investor is still over in the corner, on the other side of the ropes, biting his gum shield.

Maybe I’ve just taken too much of a battering to feel bullish. (And yes, that could certainly be a contrarian cue.)

My portfolio has been battered for over a year. While I did pretty well to sidestep the first round of disruptive tech carnage in 2021 – swapping a fair bit of clearly over-valued growth companies into my old favs, UK equity income trusts – I got greedy too soon.

Back in December I was warning that the under-the-surface growth sell-off could well herald a wider crash. Yet as I noted then, I was already seeing apparent bargains in my beloved software, cloud, and consumer tech shares.

Slowly my income trusts mostly went back out the window for fast-growers down 30-60%.

Who doesn’t like a bargain?

Unfortunately it was time to learn again that a share that’s down 80% is one that fell 50% before you bought it – and which then dropped by another 60%.

I am astonished by how far some of these – growing, cash-generative – companies have fallen. That astonishment is smeared across my portfolio in red.

Rocky

The good news for me is that on the back of my concerns about imminent quantitative tightening earlier this year – and with an eye on my leverage – I acted in February to shift a huge proportion of my portfolio into a new bucket I call ‘low volatility fixed income’ on my infamous spreadsheet.

True, even that’s since fallen 4%. It’s a shame I didn’t just call it ‘cash’. But the move has saved my net worth from a deeper ravaging.

The only trouble is I don’t want that to sit around forever while inflation has its wicked way with it.

Remember my spin on investing risk and thermodynamics:

“Investing risk cannot be created or destroyed. It can only be transformed from one form of risk to another.”

Inflation risk is one concern. Opportunity cost – missing the rebound – is another.

That’s the trouble with any sort of strategic tactical allocation market timing.

First you have to get out without doing so at the bottom.

Then you have to get back in.

Fight Club

So yes, perhaps I’m punch drunk. Read me accordingly.

Certainly it isn’t time to sell, unless you’ve realized your asset allocation or risk tolerance is far out of whack. (Even then proceed cautiously).

You want to sell when everyone is chasing rainbows, not when grizzly old veteran investors like me are feeling under the cosh.

The market has front-run a lot of this regime change away from free money – hence the turmoil. But the falls so far are hardly historic, and in the US especially they’re from extreme valuation highs.

Moreover the impact has only just begun to be felt in the real world of mortgage rates, company earnings, and that ultimate lagging indicator – jobs.

I haven’t learned my lesson, and I believe there are opportunities in the decimated growth sector.

But away from those on-the-ropes stocks, I feel there could be more of a kicking to come.

Creed

However you invest – passively or actively – this is a Joel Edgerton market where you want to roll with the punches, not a Tom Hardy one where you want to risk all for knock-out glory.

Try that and it could well come back to smack you in the face.

Here’s live footage of Mr Market in 2022 versus yesteryear’s everything-goes-up lockdown traders:

It’s been a rough six months for most of us – but it will pass.

Go for a walk. Stay invested. Add new money. Check your household budget as the economic squeeze intensifies.

And have a great weekend!

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