Good times end as rates rise

Borrowers are more likely to hear warning bells than jingle bells this Christmas.

The Bank of England is expected to raise interest rates on Thursday for the first time in nearly four years- a move that will affect every household and business in Britain. The rise is likely to be 0.25 per cent, giving a new base rate to 3.75 per cent.

This will probably be just the start. Analysts predict the base rate will reach 4 per cent by the end of this year and go as high as 5 per cent in 2004.

The effect cannot be overestimated. As Bank of England Governor Mervyn King has warned, it signals the end of an era of low interest rates, low inflation and low unemployment. It will increase the cost of every type of borrowing, from mortgages to overdrafts, from credit cards to car loans. It will stop consumer spending in its tracks. And, most worrying of all for homeowners, it will throw property prices into reverse.

Worst-hit will be families who have already borrowed up to the hilt. The British have enjoyed a long love affair with their credit cards, encouraged by cashback deals and zero per cent introductory offers.

At the same time homeowners have used spiralling house prices to increase their mortgages and spend the resulting cash. Consumer credit borrowing rose by £1.8 billion in September alone, while total lending to individuals rose by £10.7bn.

'These figures, which represent the highest total since the Bank of England began releasing them 10 years ago, go hand in hand with rocketing levels of bankruptcies, which are at their highest since 1994,' says Robert Pick, a personal insolvency expert at leading accountant Grant Thornton.

'The second quarter of 2003 saw 8,662 individuals declare bankruptcy, a rise of 14 per cent compared to the same time last year, an average of almost 100 per day. Looking at the figures, it is clear that levels of personal debt in the UK are spiralling at such a pace that for some is out of control.

'The general expectation is for a rise in interest rates as a way of countering the debt boom. While there are some good arguments for it, an increase in interest rates will lead, in the short term, to an increase in the number of people becoming bankrupt, and only a reduction in the overall amounts of personal debt after a longer period of time.

'An increase in interest rates will clearly lead to higher payments on debts and to a possible reduction in house prices, which, representing the most valuable asset of many, could force greater numbers over the brink of solvency.'

Although people are well aware of the potential for an imminent increase to interest rates, not everyone realises the impact it will have. A survey in the last few weeks by Yorkshire Bank found that 55 per cent of homeowners expected rates to rise in the next 12 months, but one in 10 said they were still intending to upgrade to a bigger and better property because the current low interest rates made it affordable.

One in five wrongly believed that a 1 per cent increase in their mortgage rate meant their monthly payment would rise by 1 per cent. They are in for a shock.

A rise announced this week will feed through to mortgage payments by December for most borrowers, just in time to blight the traditional Christmas shopping spree. A rise of a quarter per cent will push up the cost of a £100,000 repayment mortgage on the Halifax standard variable rate by £15 a month, from £614 to £629. If the base rate rises to 5 per cent, as predicted for next year, borrowers with loans of this size will have to find an extra £90 a month.

David Hollingworth at independent mortgage brokers London & Country says: 'This doesn't mean people will abandon their mortgages, throw their hands up and say they can't cope. But they will have to cut back elsewhere.'

The first thing to do to make sure you can get by is to make sure you are paying a rea sonable mortgage interest rate. 'Anyone who is paying their lender's standard variable rate is paying too much already,' he says.

Although the cost of fixed rate mortgages has risen sharply in the last few weeks, anticipating the higher base rate, competitive deals are still possible. Hollingworth recommends a loan fixed for two years at 3.99 per cent from the Britannia building society. This has an application fee of £399, but no penalties for repaying the money when the fixed period ends.

Borrowers who can afford higher repayments can get a lower rate - initially at least - by opting for a discounted rate mortgage. The Staffordshire building society is selling a loan with a discount of 2.39 per cent until February 2006, producing an initial rate of 3.05 per cent. This has an arrangement fee of £300 but no extended penalties.

Do not worry that the first rise is just days away. Remortgaging is a now quick and simple, with most lenders taking and agreeing applications online. Once yours is accepted you are fine, even if the deal involved is withdrawn from the market the next day.

If remortgaging to a new, lower interest rate is not enough to ease your money problems, you could negotiate to convert part or all of your repayment mortgage to an interest-only loan, or to extend the length of the mortgage.

However, Hollingsworth warns: 'Over the long term this means you will actually pay more interest, so it should be something you should aim to change later on when you are in a better financial situation.'

· For free independent advice on your mortgage, contact London & Country on 0800 373300.