During the worst of the coronavirus pandemic, the Bank of England had set its base rate to a record low of 0.1%. This now feels like something from another lifetime, as the current base rate sits at 2.25% at the time of writing this article. Furthermore, the BoE will most likely continue to keep raising rates to tackle ongoing inflation and other economic pressures. As a result, the current housing market feels extremely confusing to navigate. Both prospective buyers and sellers are facing the ongoing effects of these drastic changes in different ways.  

How do interest rates generally affect the housing market?  

Mortgages are a core factor in the housing market. For most of the population, mortgages are the gateway to homeownership. Very few people have access to the liquid wealth to buy property outright. This is the main reason why interest rates have a strong influence on the housing market.  

While people getting mortgages see them as liabilities, they are investments for the lenders. Lenders invest money in order to gain a return on their investments. The required rate of return is based at its core on interest rates. While other factors like risk and economic conditions may influence this required return, the interest rate serves as the core component. As such, there is generally a positive relationship between interest rates and the desired rate of return for investors. In the case of mortgages, it means that rising interest rates will almost always result in higher mortgage rates. This is also true for the reverse. That is, lower interest rates generally result in lower mortgage lending rates as well.  

How does a rising interest rate affect current homeowners?  

Homeowners generally have one of two types of mortgages – variable rate, or fixed rate.  

Those on a variable rate usually have to make payments based on the SVR (Standard Variable Rate) of their respective lenders. While other types of variable rate mortgages do exist, they are rarer and circumstantial. The SVR is generally not tied directly to the base rate of the BoE. However, changes are taken into account to adjust for the required rate of return. This means that rising interest rates result in higher mortgage rates. Homeowners on variable rate mortgages have to now spend more on each payment. But that’s not the only pressure that homeowners are facing from increased interest rates. Rising interest rates and inflation also put other stresses on the income of homeowners in other ways. Almost every form of personal and household spending becomes more expensive, while income generally stays the same. This means that not only is a larger portion of income being spent on mortgage payments, but there is also less of that income available after accounting for other expenses. This is making current mortgages unaffordable for many homeowners. As a result, many are now wanting to sell off their properties.  

At first glance, it might seem that those on a fixed mortgage are faring better. Especially those who obtained such mortgages during the record low rates of 2020 may seem to be in a very safe position. However, fixed rate mortgages are only “fixed rate” for a set amount of time. Usually, the fixed rate is applicable for only 2 to 5 years. After that, homeowners need to either re-mortgage at a new fixed rate, or switch over to paying based on SVR. Many who mortgaged on smaller time-frame fixed rates will have to re-mortgage very soon. These people are about to face what is known as “rate shock.” Mortgages that were once comfortably affordable will now suddenly become overbearing as the new fixed rates will be much higher. This will result in many of them wanting to sell too.  

The effects on prospective buyers  

Many of the effects that are affecting homeowners are also affecting the decisions of prospective buyers. The limited income problem affects the spending power of prospective buyers. Rising interest rates and inflation are eating away at their incomes as well. As a result, their spending power is on the decline. Furthermore, they are seeing the rising rates of mortgages resulting from the rise in interest rates. Additionally, the BoE’s intent to keep raising rates is common public knowledge. These factors make most prospective buyers very reluctant to enter the property market amidst rising rates.  

Are homes becoming more affordable, or less? 

At this point, you might be thinking, “Wait, so what I see is an increase in people wanting to sell, and a decrease in people wanting to buy. So wouldn’t that mean property prices should be falling?” 

Yes, you’ve made a keen observation. Growth in the housing market has basically flatlined, and property prices are projected to fall soon. After all, economics dictate that when supply is greater than demand, prices decrease. As such, one might think homes are becoming more affordable. However, it’s a bit more nuanced than that. This goes back to the rise in mortgage rates. Whether or not homes are becoming more affordable depends on how much of the value will be mortgaged. If you can put forward a large portion of the value as a down payment, the near future might be a great time to buy property. Or if you’re wealthy enough to be able to buy outright, you may find very lucrative opportunities on the horizon. However, if you have to mortgage the majority of the property’s value, it gets complicated. You will have to figure out whether the lower overall value will offset the higher mortgage rates. You also need to take into account whether you’ll be able to afford the higher payments with your projected income. Evaluating these factors can get quite complicated very quickly, and it’s best to get in touch with an experienced realtor and financial advisor.  

As interest and mortgage rates keep changing, the housing market continues to evolve and adjust. Whether you’re a prospective buyer, or you’re considering selling, stay tuned to our blog for more market insight.