How do interest rates affect the housing market? -
house interest rate

How do interest rates affect the housing market?

There is an inverse relationship between Bank of England interest rates and the housing market. When interest rates are high, demand for homes will weaken, and vice versa. When looking at interest rates and the housing market, there are several issues to consider.

Interest rates and mortgages

Whether you have taken out a fixed rate or a variable rate mortgage, at some point, a change in interest rates will impact your monthly repayments. In simple terms, the higher mortgage interest rates, the greater the interest charge and the less affordable to many people. Conversely, mortgage payments are reduced and more affordable if rates are low.

Fixed-rate mortgages

The UK mortgage market is extremely well developed, but unfortunately, it isn’t easy to fix your mortgage rate for the entire mortgage term. Consequently, whether you take out a one-year, three-year or a five-year fixed-rate mortgage, you will have a decision to make when the fixed-rate period ends. You may switch to a variable rate mortgage or seek another fixed term. The rates available at the time would depend upon underlying interest rates.

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Variable-rate mortgages

As the term suggests, variable-rate mortgages will fluctuate depending on Bank of England interest rates. Many variable-rate mortgages are available, some of which will be formally pegged to Bank of England interest rate plus, for example, 2%. So if the Bank of England base rate were 1%, your variable rate mortgage would carry a 3% interest charge. While interest rate movements can have a delayed impact on fixed-rate mortgages, they will impact variable-rate mortgages immediately.

Interest rates and house repossessions

House repossession rates in the UK are heavily associated with interest rate movements, making mortgages more affordable or expensive. If interest rates increase, mortgage repayments will rise, and many homeowners will struggle. In this scenario, some homeowners may fall behind on their mortgage repayments and see their homes repossessed.

Those with a little more leeway may decide to sell their property and downsize. In a simple supply and demand scenario, the less demand for homes or the more property for sale, the greater the downward pressure on property prices.

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Mortgage affordability tests

As many people have credit cards, bank loans and overdrafts, they may struggle to pass the mortgage affordability test. This is a test introduced after the US financial crisis of 2008 to reduce what many deemed to be risky lending in the UK mortgage market. So how might interest rates impact mortgage affordability?

If interest rates were relatively high, this would impact the cost of consumer debt and therefore leave less money to go towards mortgage payments. Conversely, if interest rates were relatively low, less household income would go towards consumer debt interest charges, leaving more for mortgage payments.

Interest rates and the economy

There is a strong correlation between economic performance and the UK property market. When the economy is doing well, there is substantial demand for property. Conversely, when the economy is struggling, demand for property tends to fall. Digging a little deeper, economic growth in the UK is heavily dependent on consumer spending and the employment market.

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The Bank of England utilizes interest rates as a relatively blunt tool to breathe new life into a struggling economy and cool an overheating one. If the economy is overheating, interest rates will rise, making consumer debt more expensive and reducing consumer spending. Conversely, if the economy were struggling, interest rates would fall, making consumer debt more affordable and increasing spending. The greater the level of consumer spending, the more potential growth prospects for businesses, leading to higher wages and rates of employment. More money to spend!

As there is a strong correlation between economic performance and the UK property market, this is an indirect impact of interest rate movements.

Interest rates and the housing market

The inverse relationship between interest rates and the housing market is based purely and simply on affordability. The lower the cost of debt, in this case, mortgage finance, the more demand for properties. The high the cost of debt, the less affordable mortgages become, which reduces demand, softening prices.

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