What rocketing interest rates mean for your house price

·5-min read
mortgage house prices interest rates bank of england
mortgage house prices interest rates bank of england

The Bank of England has announced a major blow to the property market with its sixth consecutive decision to raise interest rates.

The Bank has made its largest interest rate rise for 27 years, with a 0.5 percentage point increase to the Bank Rate. This has taken it to a 14-year high of 1.75pc, up from 1.25pc earlier today.

The Bank's five rate previous rises had already increased the average rate for a two-year fix for a buyer with a 25pc deposit from 1.57pc in December to 2.88pc in June. Today's decision will make mortgages even more expensive.

There are widespread expectations of house price falls in response to soaring costs. The Centre for Economics and Business Research, another analyst, has forecast a 3.7pc fall next year, with larger drops of 9.2pc, 7.5pc and 5.7pc in the North East, the North West and the South West respectively. Research firm Capital Economics has forecast a 5pc to 10pc drop over the next two years.

'We are entering a new era'

Today's rate rise was the largest single increase in the Bank Rate for nearly three decades. Soaring inflation means further rate rises are in the pipeline, with many forecasters expecting it will hit 3pc in 2023.

The jump could be even more extreme. In one prediction by the Office of Budget Responsibility, Bank Rate could rise to 3.5pc.

The contrast to the years of low interest rates in the wake of the financial crisis, and particularly with the record low 0.1pc rate during the pandemic, will be huge. Karl Thompson, of CEBR said: “We are entering a new era.”

House prices have already flatlined

Rising mortgage costs are hitting buyers at the same time that inflation is eroding their real earnings and reducing their ability to save. The housing market slowdown has already begun.

Month-on-month, house prices in July rose by just 0.1pc to hit £207,209. This was the smallest monthly increase in the last year and a massive drop compared to the average 0.85pc monthly growth rate recorded across the previous 12 months, according to Nationwide Building Society.

On a rolling quarterly basis, house price growth slowed from 2.3pc to 1.7pc, the weakest rate recorded since April 2021.

Lead indicators show major warning signs. New buyer inquiries in June fell at the fastest rate recorded since 2020, when the housing market shutdown, according to the Royal Institution of Chartered Surveyors, a professional body.

The three stages of rate rise impact

Rising mortgage costs hit the property market in three stages. Almost immediately, nearly two million homeowners on variable rate mortgages will see their monthly costs surge as lenders raise their standard variable and tracker rates in response to the Bank Rate.

A homeowner with a £400,000 mortgage on SVR will see their monthly payments jump by £99 in response to the 0.5 percentage point rise in the Bank Rate, according to analysis by Moneycomms, a consumer website.

Next, lenders will start to increase their rates on new mortgage deals. Pantheon Macroeconomics, an analyst, expects the two-year fix rate will hit 3.1pc by the end of the year, up from 2.88pc in June. This means buyers will have less borrowing power, and will not be able to offer as much on homes.

The third stage is slower and more insidious. Homeowners who are currently protected by fixed-rate deals will eventually have to remortgage. High transaction rates during the stamp duty holiday mean a record 1.8 million homeowners are due to remortgage in 2023.

Many of these will get hit by "rate shock", when they have to remortgage at much higher rates than they are used to. Buyers who took advantage of the sub 1pc deals available during the pandemic could see their mortgage rates quadruple.

Affordability is getting hammered

When the Bank Rate was at 0.1pc, a homeowner spent 38pc of the median income to service an 80pc mortgage on an average priced home – or £827 per month, according to Capital Economics.

With the Bank Rate at 1.75pc, assuming the increase is passed entirely to borrowers, a buyer will have to pay 45.5pc of their income towards their mortgage. This means homes will be less affordable than at any time since 2008, during the financial crisis.

The last time mortgages were so expensive, homes were cheaper in relation to earnings. In the last three months of 2008, the average house cost 5.2 times average earnings, according to Nationwide Building Society. Today, the ratio is 6.8 – the highest on record.

This would have been a constraint on house prices, but until recently record low mortgage rates meant homes were still exceptionally cheap to buy. Now, buyers will no longer be shielded from reality. Purchasing power is evaporating.

Paul Cheshire, a former government adviser and emeritus professor at the London School of Economics and Political Science, said the market was the most exposed to persistently falling prices since the early 1990s and predicted a nationwide drop of at least 10pc.

“The last time the housing market looked this bad was 1989. That’s when the hairs on the back of my neck were telling me there would be real problems. My instinct right now is that under no circumstances would I borrow a lot of money to buy a house," he said.

The spectre of forced sellers

Just as buyer demand falls, existing homeowners could suddenly find their mortgages are unaffordable if they are on variable rates or need to remortgage. Andrew Wishart, of Capital Economics, said: “When mortgage payments get into the high 40s as a percentage of median income, it usually spells trouble ahead.”

Restrictions on lending and affordability criteria in the wake of the financial crisis have meant that the British property market has improved safeguards.

But higher rates could coincide with a sharp slowdown in the economy. There are widespread forecasts of a recession, which in turn will bring rising unemployment.

“That would cause some borrowers to fall into arrears and repossessions would rise even if they have a significant equity stake in the house,” said Mr Wishart.

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