Bonds Signal Crash Landing for Fixed Rate Borrower...The recent turmoil in bond markets could be bad news for borrowers, as rising bond yields indicate that interest rates on fixed rate mortgages will increase. So homeowners whose fixed rate is about to expire should prepare themselves for a crash landing.
What are bonds and why do they matter? A bond is simply a sophisticated form of IOU. Instead of taking out a loan from a bank, a company or government can borrow money by selling bonds to investors, and paying them interest.
Whether this is a good investment depends on the price of the bond and the amount of interest it pays – a bond costing £50 which pays 5% interest is better than a bond with the same interest rate which costs £100. Both will earn you £5, however with the £50 bond you’re getting more for your money. Your return rises as the price of the bond falls.
In technical terms, the return on a bond is known as a yield – and they’ve been hitting the skies. Last week the yield on UK 5 year bonds soared to a nine year high of 5.70%, up from 4% at the beginning of 2006.
The reason for this dramatic rise in bond yields lies in the relationship between bonds and interest rates. After all, why buy a bond if you could earn more simply by putting your money in a bank account, where there’s no risk that the bond issuer will default? So as interest rates rise it becomes less worthwhile investing in bonds. As investor appetite for bonds wanes then bonds prices fall and yields rise.
In short, bond yields represent the money market’s best guess about where long term interest rates are going. So the recent rise in bond yields indicates that the market expects long term interest rates to rise, pushing up the cost of longer term fixed rate mortgages.
Two years ago the average rate on a fixed mortgage was just 4.7%, it is now 5.7% and, as the recent developments in the bond markets indicate, likely to rise even further. Thus many homeowners who borrowed on two year low fixed rates back in 2005 will face a shock as their fixed rate expires later this year.
Borrowers in this position should be wary of drifting onto their lender’s standard rate, which is likely to be significantly higher. For those with a significant amount left on their mortgage, the best option may be to re-mortgage at the best rate possible, and to do so soon, before fixed rates rise any further.
Adela Read
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