With the Governor of the Bank of England, Mark Carney, warning last summer that UK interest rates are set to rise ‘sooner than the markets expect’ there may be many homeowners and potential buyers who are wondering how rate rises could affect the UK property market.
The answer to this question is complex, because it depends on individual financial circumstances and property location. As has been well-documented, the London property market has seen a rapid rise in prices above and beyond those seen before the 2008 crisis, while other UK regions, notably the North East of England, Scotland, rural Wales and Northern Ireland have seen slow growth with prices yet to return to their 2008 peak.
Mark Carney predicts that new interest rates are likely to stabilise at or around 2.5%, a five-fold increase in the base rate for those currently holding a mortgage. Viewed simply in terms of multiples, this rise sounds alarming, threatening the affordability of mortgages repayments for first time buyers and those who may have overstretched themselves when obtaining a mortgage in the past.
However, interest rates generally rise during economic recovery and periods of growth. Economic theory suggests that in a time of rate rises we will also see rising employment, increased investment and growing consumer confidence. Rate rises in this context should be balanced out by growing consumer confidence, with people likely to spend more of their income on goods that will in turn continue to boost the economy. On the other hand, failure to raise interest rates during periods of economic growth risks rapid rises in inflation, which governments wish to avoid.
Another factor when considering interest rates is the recent fall in oil prices. With the cost of the black stuff now below $50/ barrel for the first time since 2009, many UK households will see their disposable income increase as wages rise and petrol, food and other commodities become cheaper over the coming year. Lower oil prices have reduced UK interest rates to unexpectedly low levels and many economists predict inflation rates will remain below 1% in 2015.
With inflation standing at 0.5% in December 2014, the chances of interest rate rises in 2015 look more unlikely. Mike Gibson, Head of UK Research at CBRE commented: “Falling oil prices and gas and electricity costs being removed from the inflation calculation have all but ended the likelihood of a base rate rise before the end of this year.”
So economic theory suggests that interest rate rises should not prove problematic in the near future, but there is an important caveat to be considered. Analysis from the Resolution Foundation suggests that as many as one in four UK mortgages could become unaffordable when interest rates do rise, with many UK households already stretched by rises in the cost of living since 2009. If higher mortgage repayments were added to this, many could homeowners fall into arrears. The Foundation estimates that as many as 2 million homeowners could be affected, with almost 20% already in some kind of financial difficulty.
Most of those affected are those whose mortgages were approved before the 2008 crisis, and those who took out self-certified mortgages before 2009, but it could also affect Buy to Let landlords in areas where rents only just cover mortgage payments. In this situation many homeowners may be forced to sell or find that the lender repossesses their property. In the case of landlords, it might be possible to increase rents to cover their costs.
If a number of homeowners are forced to sell because they can no keep up their mortgage repayments, will house prices fall? While this may seem a logical conclusion, further analysis suggests this is unlikely. This is because many homeowners are living in houses that are worth less than they paid for them (in Northern Ireland, it is estimated that 50% of homeowners are in negative equity), or they have borrowed such a high proportion of the value of their home that they cannot afford to reduce the asking price.
In practice, rate rises are likely to mean that fewer properties are available on the market and demand (and therefore prices) will continue to rise, albeit at a slower rate. This is despite the fact that in many areas of England (London, the South East and other affluent areas) are unaffordable for most first time buyers on average wages. It is possible that those who are in a position to buy will find themselves living somewhere smaller or in a different location than they might have first anticipated.
Economists predict that the UK economy recovery is likely to be gradual and spread over the longer term, with wage increases remaining sluggish for quite some time. Under the new affordability criteria (MMR) introduced by the Bank of England in May, first time buyers with low incomes and small deposits may find it harder to get a mortgage approved, and instead find themselves living long-term in rental accommodation.
However, the news is not all doom and gloom for first time buyers, as there are signs that last year’s rapid increase in property prices may be slowing. The Land Registry reported that the average house price in England and Wales remained steady at £176,581 by the end of Q4 2014. While prices in August 2014 had increased 8.2% on the previous year, there was a slowdown in the autumn to 7.3%.
So what can existing homeowners do to ensure that they do not fall into mortgage arrears? Experts advise that they should calculate the likely effect of interest rate rises on their repayments, and consider how they will be affected by higher mortgage payments. Those with a high LTV (loan-to-value) mortgage might consider overpaying their mortgage now if they can afford to, as many lenders allow up to 10% extra on monthly repayments. This will reduce the amount of money they owe overall, and will also reduce mortgage repayments in the future.
Mortgage customers with standard tracker mortgages might consider switching to a fixed rate mortgage, some of which offer predictable payments for up to 10 years. Although fixed rate mortgages may mean an increase in repayments the short term, it will offer financial peace of mind. Those mortgage customers who are currently on low rate tracker mortgages (around 2%) should get independent financial advice on their options. They might be better off waiting and seeing how things unfold.
Homeowners who feel they maybe at risk of falling into arrears in the future should contact their lender now to see what can be done to minimise this risk. Lenders should do all they can to ensure that the worst does not happen.