The old CPI incorporates the cost of renting and running a property, however, it did not account for some of the other costs associated with owning and maintaining it (for example household insurance and renovation costs). For this reason, the CPIH tends to be higher, even though it does not actually take into account the cost of mortgage payments and instead works on the assumption of people renting the home they own.
What could this mean for monetary policy?
In the wake of the EU referendum result, we have seen inflation rise to its highest level for two years, prompting Bank of England (BoE) governor Mark Carney to declare that he is willing to put up with a rise in inflation to keep unemployment low. How long will this continue to be the case though?
At some point, there will surely be a tipping point when the bank’s objective to keep inflation under control will take over – resulting in an increase in the base rate. Indeed, Mr Carney says: “There are limits to the extent to which above-target inflation can be tolerated.”
If the BoE also adopts the higher CPIH measure of inflation, that decision could be accelerated. For now, however, it has declined to comment on whether it will consider using it in the future, and any change in this regard is likely to take time anyway because the CPI target is built into legislation.
Borrowers can also take some comfort in the fact that many employers look at inflation costs when deciding the rate at which someone’s salary should grow. So individuals may benefit from a higher than expected increase in their salary to counter the higher cost of living during the Brexit negotiations.
The early warning signs must be heeded though. Wholesale swap rates – the rate at which mortgage lenders secure capital for fixed-rate loans – tend to fluctuate irrespective of bank rate and they have been rising since August. That is a sign that fixed mortgage rates could increase and indeed some lenders have already started to offer higher rates in recent weeks.
If rates do increase, the BoE is expected to move slowly. Nevertheless, each quarter-point hike would add £297 to annual interest costs, which currently stand at an average of £3,625.
Cautioning against complacency
Regardless of how matters unfold however, consumers clearly need to be aware of the prospect of more expensive rates and what it means for their individual circumstances. The mortgage market review (MMR), goes some way to alleviate concerns due to the new lender stress test, but the public need to be prevented from becoming complacent after seven consecutive years of record low rates.
There has also been a lot of debate in recent months about mortgage prisoners and the fact that lenders could be doing more to help them. Transitional provisions for such borrowers are not being utilised fully and there is a big concern that if rates increase, these consumers will not be able to afford their mortgage.
It must be remembered too, that many borrowers will not have benefited from the MMR safeguards, having secured their borrowing before the rules came into force in 2014.
It is therefore vital that clients are fully aware of the implications of rising rates, even if this is something people feel may not happen anytime soon.
While some allowance for interest rate increases has been built into recently-granted lending, those people that have had mortgages with SVRs for a number of years need to review them as soon as possible to ensure their affordability going forward.
(Since writing, Santander has announced it will begin accepting remortgage applications from buy-to-let prisoners. This follows Ipswich BS receiving significant interest in its remortgages supporting mortgage prisoners.)