Mortgage Rates and the Housing Market: The Big UK Squeeze

Summary

• UK house prices have soared 17.4% higher since March 2020.
• Markets expect interest rates to increase by at least 250bp within the next year, which should offset some of the gains.
• However, it means the mortgage rate could reach at least 7.8%, a record high for the century.
• As a result, an average mortgage holder could see their monthly payments increase by £439.14 a month!
• Things are worse if you are not already on the property ladder. A typical UK house costs £370,893, which would set you back £1,665.28 a month. Should you wait until next year to buy that house, you would be paying over £2,000 a month.

Why Are Mortgage Rates Going Up?

Mortgage rates are rising because the Bank of England is increasing interest rates. The bank does this to combat inflation, which is at a very high 8.6%. So, while it may help the economy, the BoE decision will make borrowing money more expensive for potential homeowners. Indeed, the average two-year and five-year fixed rates for mortgages are both over 6%.

To understand how we got here, we must turn back the clocks to March 2020. The World Health Organization declares COVID-19 a pandemic while central banks were muddling around to save their economies. Here, in the UK, the Bank of England (BoE) cut the bank rate twice – first to 0.25% (-50bps) on 11 March and then, just eight days later, to an all-time low of 0.10% (-15bps). Relief programs came thick and fast, and markets entered panic mode.

Now prices are rising, and the BoE is fighting the fire by raising interest rates. This is a contractionary policy that raises the cost of borrowing and aims to cool the economy. But it means your mortgage payments could increase, and too many hikes from the BoE could mean more inflation!

Meanwhile, in the US, the Federal Reserve is also raising interest rates, increasing the cost of borrowing for potential homowners. You can find out what to expect from the US housing market here.

What Has Happened to Housing and Your Mortgage?

Markets have rallied, including the housing sector (Chart 1). UK house prices have soared 17.4% higher since March 2020. In Wales, they have risen by a whopping 24.8% over the same period – the most across the UK.

However, just about everything else in the UK has followed a similar path. Despite inflation supposedly being ‘transitory’, the Consumer Prices Index hit 10.1% in July and has been over 5% since November 2021. The shocking figures called central banks back into action – this time to return inflation to target.

The BoE started its tightening journey back in 2021, on 16 December, raising the bank rate to 0.25% (+15bps). This tepid first move preceded four 25bp hikes and a 50bp hike, bringing the bank rate to 1.75%. As a result, the mortgage rate,¹ which had bottomed at 3.59%, increased to 5.24%! It means if you were to apply for a mortgage today, just over two years later, it would cost you an extra £303.83 a month!²

How Much More Can You Expect to Pay?

While the BoE has done a lot already, the market believes they are far from finished. They envision the bank rate at least 250bp higher. It would take interest rates above 4.25%, more than double what they are today, and the mortgage rate to 7.8%, a record high for the century (Chart 3).

What Does It Mean for Your Mortgage?

The average UK mortgage stands close to £130,000 with an average fixed rate of 1.97%. It means the average mortgage payment is £549.11 a month.³ However, mortgages in the UK are rarely issued at a fixed percentage until maturity. Instead, you must renegotiate your mortgage rate every two to five years. Attempting that now would increase a typical monthly mortgage bill by £229.14 a month (Table 1). And should the BoE follow market beliefs, it could raise the average monthly mortgage bill by £439.14 a month!

What About If You Are Buying a House?

Only 65% of households in England own a home. It means 35% of the population could be looking to buy one.

The average UK home costs £370,893, meaning an average UK person purchasing this house would have to pay £1,665.28 a month (Table 2). The price of waiting, however, could be horrific. Waiting a year could see your mortgage repayment reach over £2,000! Locking that rate in for five years would cost you £26,367.87 more than locking that rate today.

The issue is countrywide (Table 3). The average house buyer could pay an additional £816.28 a month to buy in Greater London, £455.15 a month to buy in the South West of England, and an extra £235.89 a month to buy in the North East of England (Table 3).

FAQ

Will interest rates go down in 2022?

It is highly unlikely that interest rates will fall this year. Markets are currently pricing increases out to the middle of 2023 before they start falling. But this could change significantly if inflation starts to decrease soon.

Will mortgage rates go down?

Yes, mortgage rates will fall eventually. But it is unlikely that they will fall before the Bank of England decides to start lowering interest rates.

How high will mortgage rates go?

Markets currently believe mortgage rates could reach 7.8% or more in 2023, which would be a record for the century. This would make repayments on a typical mortgage too expensive for many people.

[1] – We use the Halifax Standard Variable Rate as a proxy for UK mortgage rates.

[2] – This is based on the average UK house price of £370,893, a loan-to-value (LTV) of 75%, and that you make 12 monthly payments, each year, over a 25-year agreement.

[3] – For simplicity, we calculate the average mortgage payment as if you were to refinance the £130,000 for another 25 years at 1.97%.

Lender and Borrower Meaning

The borrower is the person who takes out a mortgage from a bank, whereas the lender is the bank offering the mortgage. The borrower applies for a mortgage and repays the loan in monthly installments. How much they pay depends on the established term and the interest rate at the time. This can change if the interest rate is ‘variable-rate’, or it can be kept the same under a ‘fixed-rate’ agreement.

Ben Ford is a Researcher at Macro Hive. Ben studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively.