Interest rates

Will UK house prices drop with rising interest rates?

Record house prices in the UK, Germany, US, New Zealand, Australia and Canada have one thing in common: historically low interest rates that have driven down the cost of mortgages, supporting demand. Still, rates are expected to rise by the end of next year in most countries, and when they do, they could undermine what has supported the fastest annual real house price growth in the countries. OECD for many decades in the first quarter of 2021.

In the UK, the Bank of England unexpectedly kept interest rates at the current all-time low of 0.1% in November, but markets Expect a hike at the December Monetary Policy Committee meeting, with further hikes likely next year.

Will real estate prices collapse as a result? The answer depends on the size and timing of the rate hikes, experts say, as well as the extent to which a shortage of properties and a strong job market continue to exert upward pressure. The forecasts vary from a slowdown in growth to an outright contraction.

The official UK house price index rose at an annual rate of 10.6% in August, an almost record pace since 2007, despite fears of a sharp correction after the reduction in the duty cut. stamp in July. In October, the Nationwide Home Price Index showed the trend continued even after the return to pre-pandemic stamp duty rates.

Lucy Pendleton, real estate expert at real estate agent James Pendleton, said this was the result of buyers rushing ahead “an almost certain series of interest rate hikes” expected over the next 18 months that turns out to be to be “a much more powerful motivation for transaction than the stamp duty holiday has ever been”.

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Boris Glass, senior economist at S&P Global Ratings, said “any increase would translate into higher costs for potential buyers and therefore lower demand, while putting downward pressure on house prices.” .

In anticipation of the rise, many mortgage lenders have already increased their mortgage rates in recent weeks.

Jeremy Leaf, a North London estate agent, said that while an interest rate hike would only directly impact a small proportion of borrowers on floating rate transactions, a hike would undermine confidence in the market at large, especially among budget buyers.

The Office for Budget Responsibility, the UK’s budget watchdog, in its outlook released with last month’s budget predicted mortgage interest payments to rise 20% in the two years through the third quarter of 2023, the fastest increase in more than a decade.

Line graph for second quarter 2009 = 100 showing OBR forecasts UK mortgage interest payments to increase

Martijn van der Heijden, chief financial officer of mortgage broker Habito, says that even if the rate increases only 0.25%, many could see their repayments increase by several hundred pounds a year.

Over 3.5 million first-time mortgage loans have been issued since the Bank of England cut its key rate to 0.5% in 2009, following successive steep cuts of 5.75% in 2007 “This is a large group of homeowners who don’t know what it is like when interest payments go up significantly,” says Tom Bill, UK Residential Research Manager at Knight Frank.

However, interest rates still have a long way to go to reach historic averages after last year’s rate cut to 0.1%, the lowest since the Bank of England was formed in 1694. Likewise, mortgage rates are hovering at near record highs. In September, the average “effective” interest rate (the real interest rate paid) on new mortgages was 1.78%, down from the 15-year high of 6.2% in 2008 During the same period, it rose by almost 6%. 2% on outstanding mortgages, lowest on record, Bank of England says The data.

Line graph of%, fixed effective rate showing rates on new mortgages hovering at record highs
UK mortgage rates have fallen for all products, with a chart showing mortgage rates for various products in August 2021 compared to August 2001. In 2001, rates were around 6%.  In 2021, they varied between 1.24 and 3.62%

Banks could absorb some of the increased financing costs into their margins, reducing rising mortgage rates, experts say. Other factors could mitigate the decline in demand due to rising rates: the labor market is strong, with companies often raising wages to attract and retain staff; and British households have accumulated savings equivalent to nearly 9% of GDP since the first Covid-19 restrictions, according to Bank of England data. “These savings are concentrated mainly in middle and upper income households, which are exactly those who have been able to buy [houses], said Glass.

At the same time, there are few houses for sale, according to the Royal Institution of Chartered Surveyors, with surveyors reporting near record houses available for sale by branch in all parts of England and Wales.

Line graph of England and Wales, 12-month moving average showing the average building stock per surveyor is close to an all-time high
Chart showing housing stock per surveyor decreased in all regions, 12-month average through September

However, other factors point to weakening house price growth.

Real estate prices relative to the incomes of first-time buyers are now at an all-time high, according to Nationwide. In London, according to Nationwide calculations, a person with an average salary can take 16 years to set aside a 20 percent down payment for a typical first-time property.

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“We expect rate hikes to slow house price growth, especially in areas where affordability is already very tight, such as LondonSays Lawrence Bowles, senior research analyst at Savills.

Line graph for England and Wales,% showing First-time homebuyers' income share spent on mortgages increased
Affordability of mortgages is worse than its long-standing average in most areas.  Graph showing first-time homebuyers' income share for mortgage payments (%).  London is by far the highest with almost 55% of income spent on mortgage payments

Overall, that means a wide variety of forecasts. Nitesh Patel, a strategic economist at the Yorkshire Building Society, said YBS expects house prices to continue to rise “but at a slightly slower pace next year”.

Glass believes that UK house price growth is already having a soft landing and “if the increases come too early or are too big, it could hit the housing market in the middle of this adjustment phase and exacerbate it “.

“We believe the rise in mortgage rates should be sharp enough to mean house prices stagnate in the first half of 2022,” is Tomb’s verdict.

An increase in the discount rate to 0.75% could cause house price growth to slow to 4% by the end of 2023, according to Andrew Wishart, real estate economist at Capital Economics. But “if the MPC embarks on a significant tightening cycle, perhaps raising the bank rate to 1.5%, house prices could fall by 4%.”

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