How Will Rising Interest Rates Impact the Housing Market?

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How Will Rising Interest Rates Impact the Housing Market?


September marks the longest run of monthly increases to the housing market since 2016 as the average cost of homes reaches £367,760.

The bank of England seeks to contain inflation as it’s expected to climb higher in further months, passing 10% this year, the highest figure since 1982. To help alleviate inflation, interest rates have risen to 2.25% marking the start of a period of recession.

Currently, ultra-low interest rates have made mortgage borrowing cheaper, inflating the housing bubble, and making homeownership difficult to achieve for renters across the UK.

First-time buyers, individuals looking to move or sell a property and property investors, are all looking for answers as to how this will impact them and whether higher interest rates will help slow the country’s property market?

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What is Inflation?

You can’t talk about rising interest rates without first looking at inflation.

To work out interest rates, the Office of National Statistics looks at around 700 products and 18,000 prices for those products to work out how much a basket of goods costs. Currently, this figure stands at 8.6%.

In the past few years, the Central Bank of England has released a lot of extra money which the government has borrowed for the NHS, furlough schemes, bounce bank loans, and because of the pandemic. This borrowed money has been put into the economy but with more money in the economy, the cost of goods devalues. As a result, the price of goods goes up, with the Bank of England expecting the cost of inflation to rise as high as 10%.

Most people will have already felt the effects of inflation. Material costs and food goods have risen in price because of the pandemic affecting the supply chain. Additionally, fuel prices have gone up, energy bills are quickly growing, and rent has gone up as much as 20% in some areas.

Many experts believe that the cost of living has gone up much more than the quoted 8.6% due to changes made in recent years to the basket of goods. For many people this will result in less disposable income, however, for investors or individuals depending on the housing market slowing down, inflation can provide a benefit.

What Is The Interest Rate?

The interest rate is what you pay for borrowing money and what banks pay you for using them to save your money with. Interest rates are calculated on a percentage of what you borrow or save over the year. Therefore, if you put £1,000 into your savings account with a 1% interest rate, you would have £1,010 a year later.

In the UK we have had historically low-interest rates for over a decade starting in the years since the 2008-2009 credit crunch. Bank of England rates even lowered to as little as 0.5%. Investors who bought their properties with a variable mortgage (as opposed to a fixed mortgage), will have felt the benefits of paying back their mortgage with low-interest rates until recently. For property investors such as landlords, the low-interest rates will have assisted in a healthy cash flow on their property. However, an interest rate of 0.5% is not a sustainable rate and as a result, the Bank of England has unanimously voted to increase interest rates from 0.25% to 1%. Since this article was written, interest rates have further risen to 2.25%.

With Inflation at 8.6%, Will the Interest Rate stay at 2.25%?

Experts are in debate over whether interest rates will stay at 2.25%. The Bank of England has historically used higher interest rates as an effective macroeconomic tool to manage inflation. Therefore, with inflation at 8.6%, and expected to rise to 10%, some experts are claiming that interest rates will have to grow to as much as 5% to manage our current inflation.

On the other hand, other experts are claiming that interest rates may rise but not as much as 5% and will remain low for a period. They are claiming this is because the government has been borrowing money during the pandemic which has contributed to the country’s national debt. Therefore, if interest rates rise, it may get to a point where the government cannot afford to meet the interest payments because the debt is too big. As a result, some experts are forecasting interest rates to increase but only marginally.

What Do Higher Interest Rates Mean for the Property Market?

For property investors such as landlords, the cost of their mortgage (if it is a variable mortgage), will likely increase significantly in the next 5 years. Therefore, property investors will likely receive less cash flow. Additionally, in 2017 section 24 was introduced which meant that if you owned a property in your own name, you have a mortgage on the property and if you’re a higher rate taxpayer, you must pay a lot more tax on your property.

If interest rates keep increasing, we will likely see many landlord’s properties stop making as much money because the increase in interest has eaten into their cash flow. Because of the way that profits are calculated even though landlords may not be making a profit, on paper they still are. As result, landlords will have to increasingly dip into their pockets to be able to pay the tax each year. Experts are forecasting some property owners will sell up, as they will be unable to afford the increased taxes and higher interest rates on their properties.

Why Can Inflation Be a Good Thing for Property Investors?

When it comes to the housing market, inflation has its benefits for the right individuals. Potentially the most positive way inflation can take effect is if we as individuals have debt. As an investor, buying a property, you borrow money to fund the housing investment.

For housing investors, money is usually borrowed to fund the investment of the property. Typically, buyers get a 75% loan to value mortgage and the buyer might put a 25% deposit in. A £200,000 property will get a £150,000 mortgage and £50,000 of our own money. Over time if we have an interest-only mortgage we pay the interest off every month, but we still owe £150,000. If we have a 20-year mortgage we will owe £150,000 but the higher, we have inflation means the true value of the mortgage is eroded with inflation. Therefore, the higher inflation rises, the less spending power the £150,000 has. On average, property value doubles every ten years.

In 20 years’ time, the property you bought for £200,000 may cost £800,000, yet your mortgage remains only £150,000. If you sell that property in 20 years’ time, you will have to pay capital gains (unless the property is your own home) but after paying the tax you would still have enough money to pay off the mortgage and have plenty left over. If you own multiple properties, the money gained from selling one property can pay off the mortgages of other properties as you work towards owning unencumbered properties. Purchasing properties for investment is therefore made financially viable due to inflation. One of the risks is higher interest rates, but this can be solved with a fix term mortgage.

Providing New Opportunities for Investors

Landlords are looking to potentially sell off their properties due to reduced cash flow caused by higher interest rates. Eventually, this opens new opportunities in the market to buy new properties and get into the housing market. Additionally, new opportunities open for investors looking to build up their portfolio of properties. With the right approach, these properties can be bought from previous landlords and made financially viable for you. One way to achieve a financially viable asset is to secure the property on a fixed rates mortgage.

Fixed Rates Mortgage vs Variable Rate Mortgage

In the UK, investors usually gravitate towards buying to let mortgages that are interest only. This means that every month you pay interest, but the capital is still outstanding. You can either have a variable interest rate mortgage, so you pay depending on the Bank of England rate. Alternatively, you could choose a fixed-rate mortgage to know exactly what you’re paying even if the interest rate changes. If you fix your interest rate you do have to pay a slightly higher rate than a variable rate. However, a fixed rate is a safer route in the case of interest rising significantly. Currently, you can get a fixed-rate mortgage for 5 years. Increasing amounts of property buyers are leaning toward fixed-rate mortgages with predicted interest rate rises on the horizon.

Cooling Down the Housing Market

Currently, low-interest rates have made mortgage borrowing cheaper, therefore inflating the housing market. As a result, this has made homeownership harder to achieve for many renters in some parts of the UK.

Research by Capital Economics has found searches for properties have fallen back and are at the lowest level since May 2020 in lockdown. Experts predict house prices to ground to a halt later this year.

With the income-to-house price ratio at its highest ever levels, the impact this will have on the wide economy is significant. With interest rates on the rise and inflation affecting household budgets, experts such as Russell Galley from Halifax are forecasting that the house price growth will slow by the end of 2022.

What’s Been Driving UK House Price Increase?

Supplying cheap credit has inflated prices. Despite interest rates increasing, they remain relatively low in historical standards. Buyers with a large deposit can still apply for a two-year fixed deal at an initial rate of 2%.

The supply of homes remains a large issue, as there are not enough properties in the areas people are wanting to move to. There is a clear split in the market between houses, which are in high demand and flats which are providing harder to sell.

The UK’s planning system has been blamed for slowing down the process of building new properties or restricting the supply. The government has put forward proposals to radically overhaul the system and replace it with zoning. This would automatically approve developments in designated areas. However, the proposal has proven to be controversial amongst the government. Some reports suggest that ministers are going to ditch the changes.

Additionally, many big developers have been recently criticised for their unwillingness to develop land they own or sell the land for development. In the meantime, the landowners have been profiting from holding onto the land.

How Will Rising Interest Rates Affect New Home Buyers?

The surge in house prices and shortage of houses since the pandemic has made it very hard for first-time buyers looking to buy their first home. Figures show we need 300,000 new homes every year in the UK due to the current shortage. We are currently not building half of that amount.

Figures released by Halifax, relating to the period before the Bank of England raises rates, show that there is not much sign of a slowdown in April regarding the UK’s property market. Despite fears about living costs and large increases in energy bills, house prices still  increasing 0.7% month-on-month marking the longest run of increases in 6 years.

Halifax says that the “race for space”, which started in the pandemic is likely to continue as people move out of apartments in cities and into bigger houses in more rural areas. However, this is opening more opportunities for buyers looking to move into apartments in larger cities.

Signs of the Market Slowing

Despite the market being busier than pre-pandemic, there are signs it will start to slow, opening opportunities for new buyers. The number of properties for sale is starting to increase, with the number of listings in the four weeks to 22nd May being 7% higher than the five-year average. Homes are also taking longer to sell this month compared to the previous month for almost all property types.

Additionally, there is an increase in properties where sellers have reduced the asking price by at least 5%. Since the second half of April 1 in 20 properties listed have had a price reduction. Therefore, the average property price reduction is 9%. For a typical UK house, this represents a discount of £22,500. Experts are stating this is a sign we have hit the peak and prices will look to slowly decrease.

Jonathan Cunliffe, Deputy Governor of the Bank of England for Financial Stability states: “I am certainty not predicting a crash in house prices. I think when the rate of increase goes down, that is a correction, and then there’s the question of whether house prices rise faster than other prices.”

What’s Next for UK House Prices?

The question of where house prices will go in the next few years, is dividing property market experts.

Tom Bill, Head of UK Residential Research at Knight Frank says “the length period of price growth appeared to have reached its summit last month. We don’t expect prices to fall but we are presumably in the final month or two of double-digit annual growth.”
“The psychological impact of rising base rate above 1%, higher mortgage rates, a cost-of-living squeeze and gradual rebuilding of supply will all contribute to the slowdown as house prices come back down to earth later this year.”

Halifax furthers the statement from Tom Bill, stating they expect house price growth to slow further as affordability becomes stretched with the house price to income ratio at its highest level. With rising interest rates and inflation, Russell Galley, Managing Director for Halifax claims that it remains likely that the rate of house growth will slow down by the end of year. As of the 1st June 2022, Nationwide figures show the annual rate of house price growth eased slightly.

Therefore, as growing inflation rates call for higher interest rates, the housing market is likely to slow down. However, housing prices are not looking to reduce as demand still outweighs supply. The number of potential buyers currently 61% higher than the 5-year average. Meanwhile, the level of homes for sale is 37% lower than normal.

Andrew Wishart – a Senior Economist at Capital Economics:

The Bank of England base rate will get as high as 3%. In addition, servicing a mortgage will become more expensive still. However, Andrew Wishart predicts that house prices will fall by 5% between the end of this year and 2024.

It might seem like the only way to protect your money is by buying income-generating property assets. These are leveraged with debt where you fix the rate for debt for the longest time possible in the future. However, the property market is not a lost cause for those looking to buy, sell or invest in the market. Conveyancing advisors are invaluable in helping you make the best decision in a time of financial uncertainty.

Expert Conveyancing Advice from Our Solicitors

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