Financial Planning

How interest rates affect house prices

How interest rates affect house prices

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The Bank of England sets the “base rate” for the UK; that is, the “cost” of borrowing money for the government. Naturally, this affects investors who may want to lend money to the government via gilts (bonds). The lower the base rate, the less interest they will receive. Also, the base rate affects mortgage borrowers. This is because banks (lenders) largely follow the base rate when setting their own rates. So, the lower the base rate, the lower the interest on a monthly standard variable rate (SVR) mortgage – usually.

However, how does the base rate affect house prices as a whole? Could movement in a certain direction push up – or pull down – average property values on the market? Yes, they can. In this article, our financial planning team explains how this can happen and what interest rates in the 2021-22 tax year could mean for your mortgage planning.

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Interest rates & house prices

Most people in the UK need a mortgage to afford to buy a property. Only a few can buy one in cash, outright. This means turning to lenders – such as banks and building societies – to borrow some of the money, after putting down an initial deposit (e.g. 10%). The “housing market” refers to the buying and selling activity of property in the UK. 

During the 2020 COVID-19 lockdown, the housing market largely came to a standstill due to the imposition of social distancing and “work from home” rules. However, since summer 2021, more people have been buying and selling property. Indeed, average house prices have continued to rise – encouraged by measures such as the Stamp Duty Holiday (expired in October). Today, the average price of a home rose to £265,668 in June – up 13.2% over a 12-month period.

There are limits on how much people can borrow money to buy a house. After all, if too many people take out large loans compared to their income, then this can put the banking system at risk of collapse. This is what happened in the 2008-9 Financial Crisis, when a “subprime crisis” occurred – partly due to too many people taking out mortgages they could not afford. To try and prevent such disasters happening again, lenders put limits on borrowing. For instance, many lenders do not let you borrow more than 4x your salary for a mortgage.

The effect of low interest rates, however, is that this lowers the monthly repayment costs of a mortgage (since lenders, largely, follow the base rate as it moves – setting theirs somewhere above it). This means that consumers can afford to borrow more for a house. In turn, this can drive up the overall cost of housing.


The outlook for 2022

Of course, nobody owns a crystal ball when it comes to the UK housing market. Yet there are indicators in the economy that can give clues as to where the base rate might end up in 2022. This, in turn, can help analysts make forecasts (informed guesses) about what average UK house prices might look like. 

Recently, the Bank of England (BoE) met to decide on whether to maintain the UK’s historically low base rate (0.10%, at the time of writing). They surprised investors in the City of London by deciding to keep the base rate the same – confounding widespread expectations that it would rise (due to rising inflation). Presently, the markets seem to expect that the base rate will rise to 1% by the end of 2022, to hit the BoE’s 2% inflation target. The Bank, however, has repeatedly pushed back against this.

Who is right? Ultimately, the BoE decides the base rate. However, economic forces might make it untenable to maintain the 0.10% base rate for another 12 months. In particular, rising inflation is expected by many economists to not be “temporary” (as the BoE claims). If this turns out to be true, then the BoE will be hard-pressed to not raise interest rates to try and “cool down” the economy. In which case, house price growth would likely be compressed as borrowing becomes more expensive for homeowners.

Of course, it may transpire that inflation falls of its own accord in the first quarter – requiring no BoE intervention. In which case, this provides good support for continued average UK house price growth. Remember, multiple forces are at work in the economy at any given time, making it impossible to predict what will happen. Unexpected events also occur (who, after all, expected COVID-19 in 2019?). This means it is usually unwise to try and “time the housing market” – for instance, by waiting for house prices to rise further before putting your property up for sale. 



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