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What is the impact of high-interest rates on the UK’s mortgage market?

Interest – it’s what you pay for borrowing money and what banks and building societies pay you for saving money with them. The Bank of England Base Rate is the single most important interest rate in the UK and determines and influences many other interest rates, including those you might have for a loan, mortgage, or savings account. If you have a mortgage or loan, a higher interest rate means your payments may go up. If you have savings, that means you may get a higher return. So, not great news for mortgage holders but better news for savers. 

The UK’s mortgage market is facing challenges as a result of rising interest rates. The Bank of England has been steadily lifting the base rate since December 2021, with 14 increases from 0.25% in December 2021 to 5.25% in August 2023. Understandably, this has a knock-on effect on mortgage rates, which have been steadily increasing, leading to a worrying time for homeowners.

In this article, we’ll look in more detail at the impact of high-interest rates in the UK’s mortgage market and how it can affect you. Hopefully, it’s of ‘interest’ (see what we did there).

Why have interest rates gone up?

Interest rates are closely tied to inflation, and rates have increased because the UK’s inflation is too high. 

Inflation is the increase in the price of something over time. For example, if a loaf of bread costs £1 but £1.05 a year later, then annual bread inflation is 5%. The Office for National Statistics (ONS) tracks the prices of hundreds of everyday items in an imaginary and regularly reviewed “basket of goods” to calculate inflation. Britain has struggled more than other countries with the surging cost of food, a shortage of workers to fill jobs and its heavy reliance on natural gas to generate power and domestic heating, all of which adds to inflation pressure.

Inflation is bad for the economy and hits those who can least afford it the hardest. Raising interest rates is how the Bank of England can help to get inflation back down. The theory behind this is that raising interest rates makes it more expensive to borrow money, meaning people have less to spend, reducing demand and, in turn, inflation.

How high-interest rates affect the housing market

The housing market is intricately linked to the mortgage market, and rising interest rates can lead to a slowdown in both home sales and price appreciation. This dynamic often results in a shift from a seller’s market to a buyer’s market, where buyers have more negotiating power. 

Higher interest rates can affect potential homebuyers who were previously on the edge of their borrowing capacity, potentially pushing them out of the market and adding to a decline in demand and increased downward pressure on prices. As a result, sellers might find it challenging to sell their properties at the price they’d like, resulting in longer listing times. Alternatively, sellers might resort to reducing the price of their home. And when the housing sector experiences a slowdown, construction and related industries can also see a knock-on effect. 

High-interest rates can also influence the decisions of property investors. With higher borrowing costs, the potential return on investment decreases. As a result, some investors might reconsider buying additional properties or may even sell existing ones. This can impact the supply of rental properties in the market, potentially leading to rental price increases as property owners look to offset and pass on their increased costs.

Another important factor in the housing market is the behaviour of lenders. As interest rates rise, they may become more cautious about lending to potential homebuyers, particularly those with higher risk profiles. Stricter lending standards might be implemented, making it more difficult for individuals with lower credit scores or irregular income streams to secure mortgages. This could create barriers to entry for first-time homebuyers and dampen overall housing market activity.

How high-interest rates affect people with mortgages

If you already have a mortgage, high-interest rates can affect you in several ways:

  • The affordability of mortgages. As interest rates rise, so does the cost of borrowing, resulting in higher monthly mortgage payments. The impact will vary depending on individual circumstances; for example, people with high LTV (loan-to-value ratios) mortgages will be impacted more than those with low LTV mortgages. Additionally, if you have a variable-rate mortgage, the cost of your repayments is likely to go up straight away. But if you’re on a fixed rate, you won’t see any change until your fixed period ends.
  • Less disposable income. As interest rates rise and borrowing becomes more expensive, consumer spending can take a hit. When households allocate a larger portion of their income towards mortgage payments, they have less to spend on other goods and services. 
  • The ability to remortgage existing homes. When rates are low, homeowners often refinance to secure lower monthly payments or tap into their home equity. However, this option becomes less attractive when rates are high as consumers have less disposable income. This may lead to people having to sell their homes because they can no longer afford the monthly repayments.
  • Mortgage defaults. Rising interest rates may lead to more mortgage defaults as people struggle to afford their monthly repayments and default on their loans.

How to deal with rising mortgage interest rates

While rising interest rates undoubtedly cause concern for mortgage holders, several factors may mitigate the impact of high-interest rates. 

Government help. There is government help for those who are really struggling, called support for mortgage interest (SMI). This is available to people who receive one of a list of other benefits, including universal credit and income support. For those who qualify, the government pays some of your mortgage interest payments, but in the form of a loan (which must be repaid with interest). Borrowers tend to pay off the loan when they sell the property or when they die.

A growing economy. Another factor that could mitigate the impact of high rates is that the economy is still growing. So, people’s incomes are still rising, which may help them afford higher mortgage repayments. 

As well as these mitigating factors, there are also a few ways to stay in control of your mortgage payments.

Budgeting. You can use a mortgage calculator to work out how your monthly payments might be affected and then create a budget and see if there are any areas where you can cut back. If increases are likely in the future, you can start building up a savings buffer so you can still afford your mortgage when they hit.

Contact your lender. If you’re struggling to pay your mortgage, you should contact your lender as soon as possible. Depending on your circumstances, the lender may offer a range of options, such as reducing the amount you pay for a short period.

Overall, the impact of high-interest rates on the UK’s mortgage market is uncertain. The market may slow down, but it’s also possible that government schemes and a growing economy will help mitigate the impact. Only time will tell how the market will react to rising interest rates. 

If you’re thinking about buying a home, it’s important to factor in the impact of rising interest rates in the future. Think about your circumstances and how you’ll be affected by higher mortgage repayments. In essence, work out what you can afford now and whether you’ll still be able to afford it if rates rise again. 

As always, get in touch if you need to know more, and we’ll be happy to help.