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Mortgage Rates – Where Next?

A key business consideration for any landlord is financing and more specifically the level and direction of interest rates. This has massive implications for their business whether it relates to additional lending or refinancing their existing portfolio.

Who would have predicted 2 or even 1 year ago that base rates would be at 1%, their lowest since the Bank of England was established in 1694. Two years ago the talk was of rampant inflation and the need to dampen this by raising rates. So given this apparent randomness in economic outcomes, is there any point in trying to make future judgements in relation to rates and the implications for our rental businesses.

Landlords need to think 1,2,5 even 10 years ahead

The answer in my view is, yes. Landlords should realise that what we are going through is a global banking crisis of unimaginable proportions. Rates are historically low which is fantastic for a landlords cashflow.

Many of us have seen rental profits up by 3,4,500% which as Alan Forsyth pointed out recently must be unique in terms of other businesses that are slashing their workforce and witnessing slumping profits.

That said running a rental business like any other business means that you have to have one eye on the future. One, two, five, or even 10 years down the line.

So what’s in store for interest rates?
We have seen that interest rates and monetary policy have been used to control inflation. The current target rate inflation set by the Chancellor is 2%. The Bank of England predicts inflation of just 0.5% in two years time. The governor Mervyn King recently acknowledged that further easing in monetary policy may well be needed over the coming months.

“Given its remit to keep inflation on track to meet the 2% target in the medium term, the projections published by the Committee today imply that further easing in monetary policy may well be required,”

He added that the length and depth of the recession will depend “to a significant extent” on developments in the rest of the world, adding that “restoring both lending and confidence will not be easy and will take time”.

Market expectations are currently indicating that interest rates fall to a low of 0.7% during the middle of 2009 and then gradually rise from the end of 2009 to 3% in quarter 1 of 2012.

Howard Archer, chief UK economist at IHS Global Insight, says: "It is also clear that the Bank of England feels that interest rates near, or even at, zero will be insufficient to stimulate recovery given that credit conditions remain cripplingly tight for the economy."

How is this likely to impact on mortgage rates?

Buy-to-let mortgage rates are influenced by the way banks borrow money. In the money markets the rates are often measured by interest rate swaps and the LIBOR rate.

Interest rate swaps are a financial tool used by banks to borrow money and subsequently lend it at a fixed rate. Therefore swap rates are a good indicator of future fixed rate mortgage levels.

On the other hand buy-to-let lenders tend to use short term LIBOR funding as the basis for their variable rate products. LIBOR does have an effect on swap rates, but swaps are, in the main, driven by the market and what traders expect to happen to rates over a given period of time in the future. Effectively swaps take a longer term view while LIBOR is a shorter term measure.

So what are swaps telling us at the moment?

Analysis of the latest swap rates from Barclays Capital provided by one of our readers show that rates are expected to bottom during the summer of this year. No surprise there, after all they haven’t got much further to go! Rates are then expected to climb slowly, hitting 3% by July 2011 and then continuing to rise until plateauing in 2017 at just under 5%. This is useful background as it obviously has a bearing on future buy-to-let mortgage rates and therefore what rates landlords could be paying on their loans. However they are not the full story.

Rate levels aren’t the full picture

As we have seen despite historic low interest rate levels lenders have not been passing these on to landlords in the form of cheaper mortgages. This is because lenders are attempting to rebuild their balance sheets and their margins. The result is that despite a base rate of 1% the cheapest variable rates available are just under 5% giving the lender an incredible margin of just under 4%. This compares to some lenders margins of just 0.3% before the crunch hit.

What should landlords do?

Therefore, landlords need to keep a watching brief. With the economic conditions deteriorating by the day, interest rates are likely to go lower and stay lower for longer than even the latest predictions. There will be no rapid bounce back for inflation or the need for rate rises. What landlords need like the rest of the economy is for banks to have the confidence to lend at reasonable margins. Until house prices stabilise and the rest of the economy then reasonable long term margin rates of 1.5 -2% are not going to be seen. This means for many of us it’s a case of playing a watching game.

My hunch is that the tipping point is likely to be 2011. At this point a landlord will be able to fix their buy-to-let mortgage rate long-term at below 5%. This could be seen as a good deal, especially if raging inflation resulting from all the current fiscal and monetary stimuli cause the economy to expand too rapidly. In which case, the Bank of England could have to respond aggressively by raising rates. The result – double digit buy-to-let mortgage rates? It has happened before, and remember landlords; we are living in extraordinary times.

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