Watch your borrowing

Warnings are coming in from the highest possible source – the Governor of the Bank of England – that we should be looking to get our finances under control in the expectation that there will be more interest rate rises in the near future.

The UK is currently built on debt. We owe banks and building societies an unfathomable £1.3 trillion. How many zeroes is that? It’s £1,300,000,000,000. Most of that is in the form of home loans, but it still leaves £213bn (£0.2 trillion) for other debts, and that includes £54bn on credit cards.

The average family mortgage outstanding is £102,000. Based on the average national income, that’s about four years worth of after-tax salary. The average family owes nearly £8,500 on overdrafts, personal loans and credit cards – and the interest on these is going to be around 15.5%. With base rates set to rise again – probably by quarter of a percent in August, and another quarter percent by the end of the year – that debt is not going to get any cheaper to pay for.

Governor of the Bank, Mervyn King, warned on 11 June that those borrowing money on a variable rate should understand that interest rates for that borrowed money will vary, and it would be unwise to borrow money that is affordable if the interest rate remains unchanged. Mr King spoke of a number of key indicators being at elevated levels. He means that the economy is still over-heating, inflation is too high and house prices are still too high as well.

That seemed a clear indication that more rate rises are to come, and other economists agree. Some are even saying that rates may get as high as 6.5%, and that rates of 6% and above are likely to be with us for some time. Although the Consumer Price Index of inflation fell to 2.5% in May, from 2.8% in April and 3.1% in March, the underlying trend is still of an increasing rate of inflation.

Other experts suggest that interest rates may stay at 6% for two years or so, and then might come down again.

The amount of borrowing beyond mortgages means that effectively there is a lot of money about. The result of that is that prices rise and therefore so does inflation. The upshot of this pattern is that interest rates will have to go up to curtail the amount of credit people are taking out to buy more goods.

The biggest debt for most people of course is their mortgage, and to keep their home they have to keep up repayments. With many borrowers nearing the end of two or three-year fixed rates at nice low levels (maybe 4.5%) this summer could mean misery for them as they are automatically switched to their lender’s Standard Variable Rate (AVR), now around 7.5%. This would mean that they will need to find and extra £200 for the interest on a £100,000 mortgage.

Some have already experienced the pain, such as first-time buyers and home movers. First-time buyers now have to use 18.7% of their income to pay for their mortgage interest. For home movers the figure is 16.3%. Both are at their highest level since 1992 – and interest rates then were 10%.

The current suggestion from brokers is to go for a tracker mortgage. Whilst not as secure as a fixed rate, trackers are currently offering better value, as fixed rates now have the two further expected rate rises built in.

Birmingham Midshires has a two-year tracker on offer at 0.81% below the base rate. The fee is 1.25%, so is best for mortgages loess than £170,000. Including the fee, the rate comes out as 0.19% below base rate, and an example is £584 per month on a £100,000 mortgage at current rates. A quarter percent rate rise would add £15 a month.

Hinckley & Rugby Building Society offers a lifetime tracker at base rate plus 0.15%, at a fee of £645. However, the rate has a cap of 5.75% until August 2009, so you have some protection against further rate rises. This would cost £623 a month.

If you really want to know what your repayments are going to be for a certain period, then you’re best to go for a fixed rate, but these are coming with increasing fees. Fees in 2001 were under £300; now they are regularly between £1,000 and £1,500. One example is with Halifax: a 5.34% rate with a fee of £1,499. That equates to £602 per month.

As for credit cards, these can be trouble. If you have outstanding debt, look at taking out a 0% balance transfer card. This allows you to transfer your outstanding balance and pay no interest on it for a certain period. This can give you time to clear the debt without it growing as you do so. But, be warned, all cards now come with a balance transfer fee – usually around 2% – and any spending you do on the card would be subject to regular interest.

Tesco has a 12 month interest free 0% balance transfer with a 2% fee. Capital One has just launched a card with 0% on transfers until May 2008, with a fee of only 1.7%.

If you don’t get a zero percent card, you should try to repay your balance in full each month. It is worth doing this even if it means drawing on savings. There is no sense in having savings giving you 3% after tax, and paying 15% or more on a credit card.