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 another major blow to the property market with its seventh consecutive decision to raise interest rates later today.

The Bank has increased its Bank Rate by 0.5 percentage points for the second month in a row, with the central interest rate rising from 1.75pc to 2.25pc.

The Bank's six previous rises have already increased the average rate for a two-year fix from 2.45pc this time last year to 4.68pc today. Today's decision will make mortgages even more expensive and there are widespread expectations of house price falls in response to soaring costs.

'We are entering a new era'

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.

House prices in the three months to August rose by just 1.4pc to hit £273,751, a massive drop compared to the average 3.5pc growth rate in the first three months of this year, according to Nationwide Building Society.

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 Centre for Economics and Business Research, an analyst, has forecast a 4.5pc fall in house prices next year in response to soaring costs.

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.

The average homeowner with on a SVR mortgage will see their monthly payments jump by £62 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. 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.

When the Bank Rate rose to 1.75pc last month, a buyer had to pay 45.5pc of their income towards their mortgage – making homes their least 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.