The US Federal Reserve recently cut its benchmark interest rate, and the Bank of England is expected to follow suit next week. Property owners and investors are naturally asking what this means for mortgages, borrowing, and their portfolios. A common temptation is to wait for rates to drop before making financial decisions, but this approach may prove costly.
Interest Rate Cuts and the Mortgage Market
UK rates are correlated with the US bond market, so a cut by the Federal Reserve often leads to similar movement in the UK. The Bank of England’s Monetary Policy Committee is due to make a decision next Thursday, and current expectations suggest a quarter-point cut followed by two more over the next twelve months. This is partly due to poor UK GDP growth figures, with the economy having contracted in the first quarter, which would normally accelerate rate cuts to boost economic activity.
However, caution is needed when relating base rate cuts directly to mortgage rates.
Five-year fixed-rate mortgages are generally recommended for investment buyers as they remove volatility, unlike two-year fixes which tend to suit speculators. Five-year rates are influenced by a range of factors beyond the Bank of England base rate.
The price of money is set by the swaps market, which is related to the Gilt market and, subsequently, the bank base rate. But they are not the same. For the past two years, the swaps market has been trading at a discount (around 35 basis points) to the five-year Gilt, reflecting a lack of mortgage demand and confidence.
If base rates drop, mortgage borrowing becomes more attractive, increasing demand. This increased demand will likely narrow or even reverse the discount in the swaps market, potentially turning it into a premium.
So if the Bank of England implements three quarter-percent cuts, a corresponding movement of 75 basis points is unlikely to be seen in five-year mortgages. It is more realistic to expect a reduction of perhaps only a quarter of a percent, which is likely not worth waiting for.
Therefore, for anyone considering remortgaging, it is advisable to proceed now rather than waiting for marginal gains in the future. Many people who secured very cheap five-year fixes in 2021 will be remortgaging next year, and waiting could mean missing out on the current lower rates before demand pushes the effective cost of borrowing up.
How hot are your properties?
As temperatures drop, and especially as year-end approaches, property owners should focus on preparing their properties for winter and improving energy efficiency.
The government’s Eco 4 scheme (Energy Company Obligation) has been removed, leaving the market in limbo regarding new grant-funded improvements. The push for a minimum Energy Performance Certificate (EPC) rating of C is still a major talking point. Currently, a property cannot be let if its EPC rating is below E. Moving the minimum standard to C would be disruptive, as approximately 74% of the Private Rental Sector (PRS) stock does not currently qualify, although this is improving.
Grant funding is necessary to make certain improvements viable. For low-value stock, the cost of retrofit (up to £36,000 to reach EPC C) is often disproportionate to the increase in property value. The government needs to support improvements because leaky property is the single largest contributor to UK carbon emissions.
The best route to C
Start with insulation and addressing the “heat loss perimeter.” This is where the biggest gains can be made. But beware fads – spray foam in lofts has made many homes unsellable, stick with the tried and tested methods.
At the same time, ensure the house can breathe. Sealing up windows and doors can cause condensation and mould and informing tenants of how best to look after homes in the winter can prevent serious problems.
Heat pumps are not suitable for all properties but are a “no-brainer” those off the gas grid and also work for most detached properties. In terraces and flats space constraints can be problematic and also limits caused by freeholds
Landlords in HMOs who include bills in the rent find it easier to recapture the value of energy efficiency improvements. New pilot schemes, like those for micro-generation via solar, allow landlords to charge tenants the value of the electricity produced, offering returns of around 7-8%.
Mortar & Margins is produced in Solihull by Propenomix. Its editors are Duncan Hooper and Adam Lawrence
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