Interest rates are going up
Interest rates have remained on the floor for the last couple of years at a 300 hundred year low. As we all know it can’t last. That’s obvious.
The meeting of the Monetary Policy Committee this week put some more flesh on the bones as to when and how quickly rates are going to rise.
Rates will rise this year
Firstly, most experts are agreed that rates will rise this year by between 0.5 and 0.75%, read more on this in the Telegraph.
Many expect the first rise to come as soon as May. Some experts were however taken back by Mervyn King’s caution in his approach to significant rate rises this week. His emphasis was placed more on not choking off the weak economic recovery by raising rates unnecessarily quickly.
Reading between the lines
Thank goodness for Mervyn King who seems to be exhibiting a strong bout of economic common sense and independence. It appears we are back to the good old days of smart people (much cleverer than you and me; even if they don’t have a hatful of A-levels with ****+++++ after them) making the decisions. A refreshing change from New Labours policy by posture.
The Governor in his wisdom and I’m sure with the backing of the Chancellor realises when it comes to the economy and interest rates he has to ‘speak with fork tongue’. What do I mean? Well on the one hand he has to pretend that he hates inflation and he is doing his damndist to squeeze it out of the system. This is partly true. He doesn’t want to spook the money markets who will lose confidence in him and the Bank if they think he has given up on his 2% target. However, this is the rub. Secretly he and the government are loving it. Why?
Killing the deflationary monster
Their biggest fear after the Financial Crash was that as the largest debtor deflation would result in their huge debts continuing to rise as the real value of money fell. This is what happened in Japan in the 80s with the result that the economy had a lost decade and arguably two with no real growth.
The government as the biggest debtor and holder of massive stakes in the banks and their debts stand to be the biggest beneficiary of any bout of inflation because ultimately it acts to reduce the size of it’s debt.
The fact is that having inflation roaring away is great news for all debtors such as landlords, that have borrowed money to finance a property because it reduces the real value of their loans. For instance, take the scenario of a 4% annual inflation rate (Mervyn King has hinted it may hit 5% this year). A one hundred thousand pound mortgage debt will have its’ real value reduced to only £96,000 over the period of one year. Think how long it would take you to pay off four grand under a repayment mortgage.
The good news for landlords
The great news for landlords is that property is one of the best asset classes to be invested in during times of inflation. Firstly, debts get eroded whilst income in terms of rent should rise. A golden scenario for many of us.
Hedging against rate rises
The downside for any of us with outstanding mortgages is that one of the key mechanisms used by government to dampen down inflation is to put up interest rates.
The course of action a landlord takes will really depend on whether they believe that interest rates will rise gently or as many people believe, that they will have to lurch upwards to choke off inflation.
The reality is nobody knows for sure. Pick a scenario and I will be able to find a bus full of economists that will support that view.
Mortgages – locking in to a good deal
The only real way for a landlord to avoid the uncertainty surrounding the future interest rate rises is to lock themselves into the increasing choice of fixed or discounted interest rate mortgages.
One of the key decisions I have to make about my residential investment portfolio this year is when to lock into the best long-term fixed rate. I may even look at a staged approach fixing different mortgages at different times and rates to spread the risk of getting saddled with a sub optimum deal.
There are now much more competitive rates in the market. This week Kensington was the first lender to enter the market with a 85% LTV product. This mortgage fixes a landlords rate at 5.99% (APR 6.20%) for 2 years.
The best 5 year fixed rate available through Property Hawk mortgages is a 5.79% (APR 6.00%) from Manchester BS available up to 70% LTV and again with a 2.5% fee.
The message for landlords is clear. We are invested in the right asset class but we need to keep a sharp watching brief on interest rates and buy-to-let mortgages. Get your buy-to-let mortgage strategy right in the coming months and it will make a huge difference to the profits of your rental business rental over the next 5 years. Get it wrong and boy it’s going to hurt!