- Interest rates might be low by historical standards…
- But high loan-to-income ratios will see affordability squeezed
If forecasters are right, the Bank of England (BoE) will have increased interest rates to 4.75 per cent later this week. Just weeks ago, it looked as though the end of rate hikes were in sight, but sticky inflation means that markets now expect the base rate to rise above 5.5 per cent.
Unsurprisingly, the breakneck speed of developments has caused volatility in the mortgage market. David Goebel, associate director of investment strategy at wealth manager Evelyn Partners, is among those who note that last week saw “lenders withdrawing products en masse and falling over each other to reprice”. Mortgage rates are now approaching the levels seen in the aftermath of the Truss-Kwarteng mini-Budget last autumn.
New buyers hesitate
The latest Bank of England money and credit data had already shown higher rates are already beginning to take a toll on buyers: net mortgage approvals fell from 51,500 in March to 48,700 in April.
Following the release, Gabriella Dickens, senior UK economist at Pantheon Macroeconomics, suggested that “buyers are putting off purchasing a home until either a large correction in house prices, or a substantial fall in mortgage rates, materialises”. She expects approvals to remain below their pre-pandemic average for most of the year.
Most existing homeowners are shielded from rising rates…
The rising popularity of fixed-rate deals over the past decade means that many homeowners are insulated from the effect of rising rates – for now. Analysis by the Resolution Foundation think tank shows that while fixed rates made up less than half of mortgage lending before the financial crisis, they accounted for more than £9 of every £10 lent last year.
This means that around half of households with a mortgage have yet to see their rate increase since the BoE started its hiking cycle. This will soon change: as the chart shows, millions of households will face higher repayments over the next few years as fixed-rate deals expire.
…while the majority of households don’t even have a mortgage
It is worth noting that only a minority of households (28 per cent) have a mortgage today, compared with 33 per cent who own outright and the remainder renting privately or in social housing. At a high level, this limits the overall economic impact of higher rates – but it does mean that the pain will be felt unevenly.
The proportion of over 65s who own a property outright has climbed from 56 per cent in 1993 to almost 75 per cent today, meaning it is largely younger homeowners who will feel the impact. Resolution calculates that repayments are set to increase by 3.4 per cent of income for 18-34-year-olds, nearly double the 1.8 per cent figure for homeowners aged 44 and above. Of homeowners overall in England, only 40 per cent have a mortgage, according to the ONS.
Rates don’t tell the whole picture
Although high by recent standards, interest rates are expected to reach a peak far lower than the double digits experienced in the 1990s. But this obscures the fact that the burden of mortgage repayments is not just a function of interest rates – incomes matter too.
Housing market analysts at Built Place have created an adjusted measure of mortgage repayment affordability, taking average loan-to-income ratios into account. In 1980, interest rates were above 10 per cent, but average loan-to-income ratios were only 1.6 – mortgage repayments were around 20 per cent of income as a result. This rose to over a quarter of income in the 1990s as 12 per cent interest rates and higher loan-to-income ratios combined to take a heavy toll.
Although interest rates are far lower today, an average loan-to-income ratio of 3.4 means that mortgage repayments have reached 20 per cent of income again. Interest rates are far lower than they were in the 1980s, but mortgage repayment affordability is already almost as strained as it was then.
What does this mean for house prices?
Economists at Capital Economics expect a further 8 per cent decline in house prices this year, as mortgage affordability weighs on demand. A house remains most people's biggest asset: falling prices could have a huge impact on their confidence, and spending choices as a result.
“Looking to 2024 and beyond, the revival in nominal house prices will be a key aspect of rising consumer confidence and the willingness of consumers to finally spend some of their pandemic-accumulated savings”, said James Sproule, chief UK economist at Handelsbanken. Although non-mortgaged homeowners will be shielded from the blow of higher interest rates, they may still feel the wider impacts.
