UK Mortgages: How Will They Impact House Prices and the Economy? 

The UK Mortgage Market 

In the UK, individuals generally choose either a fixed or variable rate when commencing a mortgage. Historically, this fixing period has been either two or five years, after which the interest rate would revert to a (higher) standard variable rate (SVR). At this point, individuals would tend to remortgage – i.e., enter a new mortgage, fixing the rate for another two or five years. As UK mortgage rates have been dropping since the GFC, the proportion of new mortgages fixing has risen to now c.95%, with the total stock c.85% fixed. Meanwhile, the proportion fixing for 5Y or longer has also risen and now encompasses the majority of new fixed mortgages. 

Even so, by international standards the fixing periods are quite short, and produce a constant churn of remortgaging. As of March this year, approximately 28% of mortgages had less than 24 months left on their fixed term, while 17% were variable. Assuming there has been no great remortgaging rush in the meantime (there has been no obvious sign of it in the data), this suggests the recent rise in mortgage rates (c.2pp in the last 3 months) will affect around a third of mortgage holders within the next year. The offset to this is that small mortgages (<£10,000) tend to stay on SVR, and flag as variable in the data.  

Understanding the Rise in Mortgage Rates 

UK mortgage rates have spiked higher, driven by the moves in UK rates. The BoE’s bank rate drives changes to “tracker” mortgages (a variable rate mortgage that tracks bank rate) and will influence SVR rates (the default, most punitive rates offered). However, it is the shape of the curve that more directly affects fixed mortgage rates (Charts 1, 2, 3 and 4). 

Rise in GBP Rates Has Driven the Recent Mortgage Rises 

Did the Mortgage Market Break? 

The move in mortgage rates since the fiscal-event have certainly captured headlines. However, they were not the consequence of a broken mortgage market but rather of markets pricing a lot of hiking (and uncertainty) into UK rates. Put simply, if a bank lends for a 5Y fix rate (it is long a 5Y bond), it will pay on a 5Y swap to hedge itself.  

The so-called break in the mortgage market (i.e., the pulling of mortgage products) following Chancellor Kwarteng’s disastrous ‘fiscal event’ was due to the unusual moves in the swap market through that period. Uncertainty around whether the BoE would swoop in with a rate hike, a huge amount of announced supply in the short end (<7Y) by the DMO, and a general flight from UK assets saw 2Y and 5Y GBP swaps jump 130bp in a few days. In such an environment, banks were understandably unwilling to commit to lending rates. 

How High Can the BoE Hike? 

The market is pricing BoE hiking to 4.8% by the middle of next year (down from 6.5% at one point). It is this pricing driving the high short-end swaps, and hence the high mortgage rates. Were the BoE to realise this hiking path, mortgage rates would not necessarily need to rise further. They would only need to rise further if they were to suggest that they would hike even further, or if the market became convinced they would leave rates that high for longer.  

In other words, further hikes will not necessarily hurt most mortgage holders any more than they have already. They will instead hurt those with variable mortgages (SVR, tracker and discounted rate mortgages). Meanwhile, if the BoE feels mortgage rates have risen unjustifiably high, they their best method for pushing back on this would be to soften market expectations for total hiking. 

How Painful Will the Feedthrough From Mortgages Be? 

We covered the pain for UK households from the cost-of-living crisis some time ago. Since then, the pressures on households from energy price rises at the end of this year have subsided due to government support (further out they are less certain). But the mortgage situation has deteriorated dramatically. For context, households in need of remortgaging soon will see the burden of their mortgages triple (75% LTV 2Y fix this time in 2020 was 1.9%, while 5Y fix in October 2017 was 2.0%). For an average salaried person remortgaging a £160,000 mortgage (the average for a 2020 purchase) this year, mortgage interest would rise as a proportion of net income from 20% to over 50% (Chart 5). 

In the short term, the proportion of people remortgaging will probably fall as people are reluctant to lock in this higher rate before necessary. Many more will probably choose to drop to SVR (c.5%), which is less punitive than the 5.5% 2Y and 5Y fixes, but which will also rise ahead. As time passes, and the expectation for a mortgage rate decline reduces, the effect will build. 

New Buyer Demand to Come Under Pressure 

With the cost of a new mortgage 2pp higher than just a few weeks ago the impact will hit the most leveraged borrowers (first-time buyers) most. Calculations suggest this will amount to a c.£4,000 per annum reduction in disposable income – a substantial chunk.  

Reduced Buy-to-Let Profitability Could See Supply Rise 

Also notable is the impact on buy to let (BTL) properties. Historically, BTL mortgage rates have moved with a spread of around 50bp above the average. This had narrowed in recent months as the base mortgage rate has shot up but appears to have widened again since, leaving 2Y and 5Y fixes at around 5-5.2% (down from 6.5% previously). 

This is an important change in the dynamic of the rental market. Buy-to-let mortgages for house purchases have risen through 2022, ticking up as a percentage of total business to c.14% and constituting c.8.7mn homes in Q1 of this year (Chart 6). For much of this set, the rental yield will now fall below mortgage interest costs (Chart 7). This year alone, the average spread of rental yield over BTL mortgage interest rates has dropped from 3pp to 0pp. While many BTL owners will be locked into fixes and be insulated for now, those whose fix periods are ending will increasingly need to sell to avoid unprofitable business or raise rents to increase their yields. For those with interest-only mortgages, the need to sell before house prices fall may add to the momentum. 

Regionally, BTL Will Probably Affect London Most 

Chart 7 shows the areas in the UK in which BTL yields look worst. The North East is most insulated, while the South East and London are under the most pressure. However, the regional exposure to the situation is more nuanced. For instance, research suggests that around 50% of London sales in 2022 were marked as second or additional properties (the majority BTL). This suggests most BTL exits (and hence selling pressures) may be seen there. Given London rents are already elevated versus the rest of the country as a proportion of income (35% vs 30% for rest of UK), the capacity for BTL owners to significantly raise rents may be limited – hence even greater need for selling. 

The Path to House Price Declines 

BoE analysis tends to point towards an 18-month lag between policy rate changes and the real economy. For the house market, the more important rate will be the mortgage rates (which, given they are priced off swaps should pre-empt actual rate moves). On that basis, the YoY rise in mortgage rates seen so far is far greater than in any period since at least 1996 (Chart 8). The offset to this may be the reduction in stamp duty (estimated at around 7% reduction in burden). However, were this to be entirely covered in price change, it would account for just 0.12%. 

Adding to our previous comments on regional exposures, we can see that at the end of 2021, new mortgages in London were far more likely to be variable rate than in other areas (Chart 9). Taking this, along with other measures for vulnerability probably leaves London looking most exposed in terms of house price declines (Table 1).  

Consumer Squeeze and Credit Growth 

The squeeze on consumers will build the longer mortgage rates stay high, with the proportion shifting onto variable rates likely to rise given how high current fixes are. This will, in turn, leave households more exposed to bank rate. The upward impulse for rentals (required to keep BTL borrowers afloat) will add to this, as will the fall in wealth effect on the back of house price declines. Since the GFC, feedthrough from bank rate to mortgage arrears has tended to be around 18 months (Chart 11). As such, we have yet to see the full impact on households. However, there is reason to expect that after such a large rise, the feedthrough may be faster. 

While mortgages have tended to be fixed longer (increasingly 5Y or more as previously discussed), this process began in earnest in early 2018. This suggests that into early 2023 there will be a building wave of 5Y fixers needing to remortgage. Meanwhile, the decline in the savings rate will likely trigger a rise in consumer borrowing. This has tended to be the trend since the GFC (Chart 12). This, along with the shift in mortgages towards floating rates, suggests higher household exposure to rising interest rates and a shorter feedthrough from monetary policy into the real economy.  

Henry Occleston is a Strategist, who focuses on European markets. Formerly, he worked in European credit and rates strategy at Mizuho Bank, and market strategy at Lloyds Bank.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)