The first step to preparing for higher interest rates
Even though the Bank of England has reduced interest rates to a historic low, many looking for a buy-to-let investment property are worried about how their investment will be affected by a mortgage rate increase.
In this post, I’ll look at the possibility of mortgage rates going up. You’ll also learn how interest rates affect property prices, your costs, and the taxes that you pay as a buy-to-let landlord.
Why do interest rates rise?
For the most part, interest rates are used by central banks (such as the Bank of England in the UK and the Federal Reserve in the United States) to control inflation. If inflation rises, the central bank will increase its base rate. This forces high street banks to raise the interest rates they charge their customers for credit and loans. By making borrowing more expensive, the Bank of England hopes to reduce demand – and lower demand means inflation falls.
Are mortgage interest rates about to rise in the UK?
A few months ago the answer to this question would have been, “yes, probably”. The economy was picking up nicely, jobs were being created, and prices were rising. But a lot can happen in a few months. Interest rates look like they could even fall again. Inflation has fallen, primarily because:
- supermarket competition (thanks to Aldi and Lidl) has reduced food prices, and
- a collapse in the oil price has reduced fuel and energy prices.
On top of this, the fears that Brexit will damage the economy has led the Bank of England to reduce the base rate to just 0.25%. When the cut was made, investment news sources noted the Governor of the Bank of England, Mark Carney, said that rates could be cut again. He’s also urging banks to pass on the benefits by reducing mortgage rates by the amount of any cut in base rates.
So it looks unlikely that mortgage rates will rise in the UK any time soon. However, as I just explained things can change quickly. It’s always best to be prepared for a rise in mortgage rates – expect the worst and hope for the best.
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What happens to house prices if the mortgage rate increases?
Your first concern might be how the value of your buy-to-let property investment will be affected if mortgage rates rise.
There are many factors that affect property prices. These include location, local infrastructure, public transport options, regeneration projects, and so on. The mortgage rate is just one factor. All of these factors summed up influence demand. When demand falls, it follows that property prices are likely to go the same way.
As a higher mortgage interest rate increases the cost of buying a house, people are less able to afford higher priced homes. Often, when mortgage rates rise, the first affect you’ll notice on home prices is a slowdown in the rate of price growth at the higher end.
How does a mortgage rate rise affect the buy-to-let investor?
Assuming you have invested with the benefit of a mortgage, your interest payments will probably rise (unless you have a fixed rate mortgage). This will reduce your net rental income. However, you can also claim tax relief on the interest you pay on your buy-to-let mortgage – so the reduction in net income will be offset at least partly by a lower tax.
If your mortgage interest payments rise too high, then you could find your cash flow turns negative. If you’ve allowed for this in your cash flow projections, then you’ll have put in place a buffer that will see you through a period of higher interest rates until you can raise the rent you charge.
We always recommend taking a conservative and cautious view and factoring in an increase in your mortgage payments. You can watch our investment guide video about working out cash flow here.
Property value and Investment Value
Investors tend to value properties differently to home buyers. A home buyer falls in love with a house. Your investment property is a box that generates money. If the net income it generates falls because the mortgage interest rate has increased, then the property is worth less to other investors.
What will be the impact of rising interest rates have on your investment opportunities?
If you’ve invested for the long term, you’ll understand that interest rates go up and down. When they rise, your cash flow is likely to fall, unless you can raise the rent you are charging. The value of your property may also fall as part of the property market cycle.
The good news is that you’ll be prepared for this. As a savvy investor, you’ll understand that this is all part of the natural ebb and flow of the property market. My next investment guide – six buy-to-let investment strategies to negate a mortgage rate increase will make sure your buy-to-let property portfolio comes out the other end even stronger.
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