Hello and welcome back to Mortgage Advisor on FIRE. This week I talk about mortgages, interest rates, and the impact of compound interest on FIRE plans. First, the Quote of the Week:
Quote of the Week
One of the biggest stories of the week has been the increase in the Bank of England base rate from 0.25% to 0.5%. What should also be a wake-up call for many people is the suggestion that several members of the MPC wanted to raise the base rate further.
What is the base rate?
There is a complex answer, and there’s a simple answer. I’m not going to dwell too much on the former because defining the base rate isn’t what I’m driving at today, but it’s useful to have a basic working definition. So, the base rate is simply the rate of interest the Bank of England charges other banks and financial institutions for loans. The banking system is more complicated than each bank just having a pot of money they lend and store. Money is constantly flowing between banks, and the deeper you dig, the more it can make your head spin.
For the average person on the street, the base rate has a knock-on effect on the rates banks offer on mortgages, loans, savings and so on. I’m going to talk specifically about mortgages today though.
In the mortgage world, there are many different types of interest rates. Many homeowners will be familiar with fixed rates, variable rates and tracker rates. There are also capped rates and stepped rates, for example, amongst a variety of weird and wonderful products. In one way or another, these deals are impacted by the base rate whether that be instantly or over a longer-term.
The average UK mortgage debt is approximately £140,000. Assuming a 20-year term and a repayment mortgage, if you were on a tracker which tracked the base rate at 1% above, your rate would have increased from 1.25% to 1.5%. This would increase your payment from £660pcm to £676. For some people, this is a negligible increase but for other households it can mean the difference between eating or skipping lunch. If you are struggling with your mortgage payments please don’t stick your head in the sand. Contact your lender, and they will be happy to work with you to lower your payment. If they can’t, then you can seek advice from one of the organisations I’ve listed at the end of this blog.
I think that the next few years are going to be a bit traumatic for some homeowners, and as we approach the middle of the decade there may very well be a mini fire sale of properties. With property prices booming over the last few years, and a proliferation of first-time buyer incentives such as Help to Buy, which starts to sting after five years when the HTB companies start turning the screw encouraging you to pay, there are going to be a lot of homeowners who overleveraged to buy their dream first home with the assumption that rates were not going to rise in the short to medium term. I wouldn’t be surprised if the base rate tops 1% by the end of 2022, and some are predicting it could be as high as 1.5%.
Depending on where you look, the average purchase price for an FTB house in the UK is around the £250,000 mark. Assuming a young couple who took out a deal at 1.5% over 30 years on repayment, their monthly payment would be approximately £863. When that deal comes to an end, if rates have increased across the board by a further 1.5%, then they may be looking at a product transfer to a rate of 3%. This could add almost £200 to their payment.
What can you do?
The first thing to do if you’re worried about mortgage payment increasing is contact your lender. Don’t be afraid to say you want a lower payment. It might take some time to have the full discussion, and you might need to dig out information on your finances but you could potentially save a lot of money. It’s worth the effort.
Another consideration is that if you can overpay on your mortgage without severely impacting your finances, then it might be wise to do so. £50pcm extra is £600 a year. If you are on a five year fixed deal then your balance at the end of that fixed period could be £3,000 less than if you hadn’t overpaid. Then, when you are looking for a new deal you may be able to take advantage of a reduced loan-to-value which opens up lower rates. Also, a lower balance means a lower payment even if the rate is unchanged.
What you absolutely must not do is ignore this and hope it goes away. I fully expect the next year or two to be difficult for most people financially. The sooner you act, the more chance you have of mitigating any impact on your household finances.
Sometimes labelled as “the most powerful force in the universe” compound interest is at the heart of FIRE. It’s the idea that you earn interest on your interest. This can be very damaging when you look at compound interest on debts like credit cards, but when it comes to saving or investing, it’s hard to argue against the power of compound interest.
If you are investing £100 each month and earning compound interest at a rate of 10%, after 20 years your investment would be worth approximately £75,000 despite your deposits totalling just £24,000. Compound interest does all the heavy lifting and this is a huge part of why the wealthy are able to maintain their wealth; every single penny they have is working around the clock to create more money. So long as you can live on less than the amount of interest generated, your wealth continues to compound. When you reach this point, you have reached critical mass.
I was not feeling well the previous week but after making some substantial changes to my diet I’ve been feeling much better. I’ve been tired this week and I’m feeling ready for a holiday. I’ve only got two more weeks of work before I have almost three weeks away. I’d love to say I’m going somewhere warm, by the sea but that is not the case.
The total clusterfuck that is the Tory government continues to hang on, somehow. With the cost of living increasing across the board, and interest rates rising, and the contempt that the Tory party have for the majority of the UK population, how much longer will it be before people start protesting?
After the base rate increase, the biggest story of the week is probably the pressure mounting on Boris Johnson following, well, basically a lifetime of being a complete douche. His latest embarrassment was making misleading claims about Labour leader Sir Keir Starmer. As much as I’m enjoying the memes from this shambles, it beggars belief that the Tories keep doubling down on their mistakes. Then, there is the inexplicable support that Nadine Dorries is lending the Prime Minister. The whole situation seems like badly written fiction.
In other news, the repair work on our BTL has started. It’s going to be a relief once the work is done, following a very stressful few months. The big decision is whether to sell or rent it out again.
Another story that caught my eye this week was the massive drop in Meta’s stock price. Following the breaking news that Facebook’s user base has shrunk for the first time, in addition to other news about Meta’s performance in other areas, the share price of the company nosedived wiping hundreds of billions off the company’s value. I don’t like Facebook. I use it out of necessity, but it’s not a great service. If it wasn’t for my blog, I would come off Facebook completely.
A Brief Interlude
I’ll never hide this blog behind a paywall, but it does cost money to run the site. I spend a minimum of six hours each week writing the blog, and maintaining the other parts of davidscothern.com. It is a labour of love. However, many of you have asked how you can show your appreciation. I set up a Buy Me A Coffee page but the main feedback was that you couldn’t pay by card. Well, now you can! My page now supports card payments and Apple Pay. So, if you want to show your support and appreciation for the content I create, please buy me a coffee.
2022 Goals – to be achieved by 31/12/2022
1 – Reduce weight to 90kg. (Current weight 125.6kg).
2 – Complete 10 “classic” books.
- Crime and Punishment by Fyodor Dostoevsky (1866)
- Moby-Dick by Herman Melville (1851)
- Dracula by Bram Stoker (1897)
- Catch-22 by Joseph Heller (1961)
- The Iliad by Homer (8th century BC)
- The Count of Monte Cristo by Alexandre Dumas (1844)
- War and Peace by Leo Tolstoy (1867)
- A Tale of Two Cities by Charles Dickens (1859)
- Les Miserables by Victor Hugo (1862)
- Don Quixote by Miguel de Cervantes (1605)
3 – Read 10 authors I’ve not read before.
What Am I Doing?
What I’m reading: Firefall by Peter Watts
What I’m listening to: Helios: Cerberus Book 2 by Jeremy Robinson and Sean Ellis
What I’m watching: nothing at the moment
I’m starting to make some progress with Firefall. It’s interesting but has an unusual style. Once I’ve finished with Helios I will have completed all the Chess Team books and their related works. There is a final book due in the main series and I can’t wait. This series has been brilliant, and if you like military fiction with a supernatural/sci-fi twist, I can’t recommend it highly enough.
Premium Bonds: £14,700.00 (no change from last update).
Stocks and Shares ISA: £45,520.53 (down £120.32 from last update).
Fuck It Fund: £3,500.00 (no change from last update).
Crypto: £532.42 (up £40.26 from last update).
Pensions: £51,448.78 (up £972.84 from last update).
Residential Property Value: £213,900.00 (no change from last update).
Buy-to-Let Property Value: £138,030.00 (no change from last update).
Total Assets: £467,631.73 (up £892.78 from last update).
Credit Card: £0.00 (no change from last update).
Residential Mortgage: £165,264.71 (down £392.67 from last update).
Buy-to-Let Mortgage: £92,939.80 (down £18.37 from last update).
Total Debts: £258,204.51 (down £411.04 from last update).
Total Wealth: £209,427.22 (up £1,303.82 from last update).
Investment Income in 2022: £137.51 (target £6,000).
No major changes this week with some small losses in my ISA and some modest gains in my pension. I suspect that the stock market may stagnate a little until we get some sort of stability with inflation and interest rates. This is going to take time though, and we could see a dip if enough people lose their nerve and start selling their holdings. As a long-term investor, any dip in share prices is an opportunity to make pound-cost-averaging work for me.
The next week should see my contributions to my pensions actioned for the month, then the week after is when I receive my salary. Before you know it, we’ll be in March and within touching distance of the new financial year. It’s my intention to maximise my ISA allowance as early as possible in the financial year.
I’m less than two years away from my target date for FIRE. The rational part of my mind knows it will be a huge challenge to hit that date. However, I don’t think it will take much time beyond the end of 2023. Even if I don’t hit my target, I will still be in a much better position than if I had not made the attempt.
Overpaying your mortgage or invest?
This is a common question on FIRE message boards and subreddits. I have done the calculations a few times and in the long-term it makes more sense to invest. However, this assumes that rates remain somewhat stable and linked, with the rate of return on investments and that charged on debts maintaining a steady relationship.
One thing that you can’t put a price on is peace of mind. Paying your mortgage off faster means that you will own your home sooner. There is a huge psychological boost from knowing you own your home outright. This is probably even more important to those with families or dependents. The most important thing to remember with any financial decision is that what is best for someone else might not be best for you. Education and experience is the key.
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I spend several hours each week writing this blog and make it freely available to all readers. I do not hide my content behind a paywall. However, maintaining a website incurs costs. If you can afford a small donation, it would be gratefully accepted. Click on the Buy Me A Coffee image to be taken to my supporter page. You can either make a one off donation, or sign up to a monthly subscription. If you can’t make a donation, please share my blog on your social media.
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Finally, have a look at Darren Scothern’s fantastic blog at darrenscothern.com.