Borrower preferences are evolving with the end of rate rises in sight

Lucy Waters - Managing Director of Aria Finance

It's unbelievable to think that, until the middle of last year, at least 3.8 million borrowers in this country had never experienced an environment where interest rates were above 1%.

For nearly 12 years, we had become used to the notion of rock-bottom interest rates and the ultra-low monthly repayments that came with. 

While most borrowers during that period would have expected rates to rise eventually, the pace at which they have done over the past 22 months will have come as a major shock. 

In fact, the last time interest rates rose this quickly, Margaret Thatcher was Prime Minister, the Berlin Wall was still standing and Look Who's Talking was showing in cinemas.

That was 34 years ago and so the number of borrowers from that period who remember what it was like and are still repaying their mortgages will be relatively small. 

Therefore, the past two years have been completely unchartered for millions of borrowers, and a highly confusing and worrying time to boot.

It's interesting then to observe how borrowers' preferences have evolved and changed, first when rates were soaring and now that the current rate hiking cycle looks to be coming to an end. 

In the six years to 2022, the five-year fixed rate overtook the two-year fixed rates as the nation's most popular mortgage product. 

There are two very good reasons for this. Firstly, this was a time when mortgage rates hit record-low after record-low. As a result, it made sense for most borrowers to lock into an ultra-low longer-term fixed rate rather than going through the hassle of refinancing every two years.

But regulation also played a part. In 2014, the Bank of England introduced new affordability rules forcing lenders to check if borrowers could still afford their loans if rates rose by 3 percentage points.

Crucially, though, the rules only applied to borrowers fixing for up to five years. Effectively, that made it easier to get a mortgage if you fixed for five years or more, so it's unsurprising then that they became a more popular option for borrowers. However, it must be noted that some lenders decided to stress five-year loans even though the rules didn't require them to.

While the BoE scrapped that stress test in August last year, five-year fixed rates became even more popular, peaking in December 2022, when they accounted for more than 67% of new mortgages. 

That’s understandable. At that time, interest rates had risen 3.5 percentage points to 3.5% in just 12 months and were predicted to surge much higher. Borrowers were merely trying to protect themselves from further rate increases.

However, things have now changed. The BoE’s Monetary Policy Committee voted to hold rates at its past two meetings, albeit by a small margin.

Talk of this being the end of the current rate rise cycle is becoming louder and more widespread, with some economists predicting that the BoE will even begin to cut rates next year.

Borrowers are cognisant of this and are starting to act accordingly. BoE data shows that it is actually the two-year fixed rate which is now once again the UK’s most popular mortgage product, despite being pricier on average than five-year fixed rates. At the end of June, they accounted for nearly one in two transactions, the BoE’s data shows.

There has also been a noticeable uptick in the number of borrowers opting for tracker mortgages. The same data shows that ‘floating rates’, as the BoE calls them, accounted for more than 15% of new mortgages in June, up from 4% a year earlier.

That tells me borrowers sense the end is in sight for the current rate hiking cycle and are looking to profit from potentially cheaper mortgages sometime in the future.

As us professionals know, we cannot take it for granted that rates will fall from here. If inflations proves sticky, or even rises, the BoE won’t hesitate in increasing rates once more. Some market observers, such as JPMorgan, believe we may even see interest rates reach as high as 7%.

But even if rates do fall in the next year or two, as some expect, I believe borrowers will need good, independent advice as much as they did when rates were rising.

And if the trend is towards shorter-term fixed rates and trackers, it will provide a much-needed boost in activity for what was promising to be a tough market next year and the year after.