Rising house prices have been a key driver of UK economic growth since the 2008 financial crisis. Total mortgage lending reached £316bn ($402bn) in 2021, the highest since 2007.
The average UK house cost around nine times average earnings in late 2022; the highest since 1876.
Loans to finance those purchases were more affordable when the Bank of England (BoE)’s benchmark lending rate was near zero.
Now it’s 5% and likely to rise.
As the BoE ratchets up the cost of borrowing to quell stubborn inflation, millions of mortgage holders are finding their disposable incomes eaten up by interest payments.
The risk is a sudden hit to consumer spending that tips the country into a recession before the bank has managed to get prices back under control.
This problem of unintended consequences is not unique in the world of monetary policy-making. But it’s especially acute in the UK, where the popularity of short-term mortgage deals leaves homeowners more vulnerable than elsewhere to sudden spikes in interest rates.
Official data last week showed UK annual inflation at 8.7% in May, unchanged from April, causing the BoE on Thursday to hike its key interest rate by a larger-than-expected amount.
The half-point lift to a 15-year peak of 5% was the 13th increase in a row. Economists are predicting rates could hit 6% this year, which could see the UK follow the eurozone into recession.
The vast majority of UK mortgage holders have fixed their interest rates for just two or five years, unlike in many other countries where 10 and 30-year fixed mortgages are more common. It’s still a better situation than in the 1980s, when the majority of households were on variable-rate deals that exposed them immediately to volatile interest rates.
Still, lots of households face sharply higher repayments when their fixed-rate deals end and they need to negotiate new terms — 1.3mn of them between April and the end of the year.
With the country already gripped by a cost-of-living crisis, many will struggle to pay thousands of pounds more per year on a mortgage.
Markets are currently pricing in interest rates above today’s level through the end of 2024 and beyond. The current benchmark lending rate of 5% is not far off the average of 5.25% over the past 100 years.
The Institute for Fiscal Studies estimates that higher interest rates will cause the average mortgage holder to suffer an 8.3% fall in disposable income compared to a scenario where rates remained at March 2022 levels.
The surge in mortgage rates is worsening a housing affordability crisis blamed on decades of underinvestment in new homes.
For the governing Conservative Party, home ownership has been core to its appeal to voters since the 1980s, and a point of differentiation with the rival Labour Party.
Years of rock-bottom interest rates and low rates of home building increased property values in the past decade and made many Britons feel richer, but it’s now much harder for younger people to afford a first home.
With housing at the heart of the economic pain, homebuilder stocks have fallen almost 20% from a recent peak in early May, and are at their lowest this year.
A misery index by Bloomberg Economics that combines inflation, unemployment and mortgage costs is at elevated levels, with the mortgage component growing in impact.
Finance Minister Jeremy Hunt on Friday agreed support measures with major UK mortgage lenders for struggling customers, including those in arrears. This included a 12-month minimum period before repossessing homes.
But rising mortgage payments are squeezing the finances of millions of borrowers in Britain, threatening to undermine household spending and the broader economy. The dream of a soft landing that would have the BoE squeeze out inflation without condemning the country to a recession looks increasingly remote.
The Institute for Fiscal Studies estimates that higher interest rates will cause the average mortgage holder to suffer an 8.3% fall in disposable income compared to a scenario where rates remained at March 2022 levels