Why house prices will keep falling even as mortgage costs drop

Lenders are cutting mortgage rates in response to expectations the Bank of England base rate will peak this autumn, but experts still predict further house price falls.

According to price comparison website Uswitch, 10 mortgage providers cut their rates in the week leading up to 11 September as most economists predict the Bank of England base rate will peak at 5.5 per cent or 5.75 per cent after one or two more hikes.

Tom Bill, head of residential research at Knight Frank, told Investors’ Chronicle that the other factor driving down mortgage rates was competition in a sluggish market. The high-street lenders, he said, were not as impacted by what happened in the swap market. As such, they were cutting rates based on their rivals' behaviour. “Think of it like a peloton in cycling: lenders want to be at the front of the pack,” he said.

Mortgage rates have been falling for a couple of months. The average five-year fixed rate is 5.67 per cent after peaking at 6.11 per cent in July, according to property portal Rightmove (RMV). The company said the result of this has been fewer “fall-throughs” in property deals, with more certainty from buyers over their rate, allowing them to stick by their decisions.

‘A bit of stability’

However, Bill said even though more confident base rate predictions have reduced market volatility, house prices would continue to fall this year and next. Knight Frank has forecast a 5 per cent annual fall in UK house prices by the end of 2023 and a further 5 per cent fall by the end of 2024, a prediction unchanged from October last year. 

“Everyone knew base rates were going to rise, but we haven’t had a steady ascent,” he said. “It’s been all over the place. It’s been volatile, and that really knocks sentiment. And sentiment is a vital but subtle lubricant for the housing market.

“Once we do get a sense the Bank of England has reached the top of its cycle, that will have a positive impact on sentiment. Not to the point where the market is firing on all cylinders, and prices are rising again, but there will be a bit of stability in the market.”

Earlier this month, rival agency Hamptons predicted a near-10 per cent total fall from the beginning of 2023 to the end of 2024, although it anticipates that this will come from a 7.4 per cent drop this year and a 2.5 per cent drop next year. The Office for Budget Responsibility’s most recent prediction is similar: a 7.2 per cent annual drop by the end of 2023 followed by a 2.9 per cent drop over 2024. The timing of the predictions varies, but there is widespread agreement on a total house price drop of around 10 per cent (see chart).

Knight Frank’s Bill said he continued to be bearish, despite the increased clarity on base rates, because interest rates will remain elevated long after the peak passes this year. He said that homeowners coming off a two-year or five-year fixed-rate deal in the next couple of years will add to the prolonged housing market hesitancy.

Others argue house prices would continue to fall because higher interest rates were only now beginning to feed through to the housing market. In Halifax’s housing market update earlier this month, director Kim Kinnaird said: “It’s fair to say that house prices have proven more resilient than expected so far this year, despite higher interest rates weighing on buyer demand. However, there is always a lag effect where rate increases are concerned, and we may now be seeing a greater impact from higher mortgage costs flowing through to house prices.”

The impact of this lag effect is a seven-year high in mortgage arrears. According to the latest Bank of England data, the value of outstanding mortgage balances with arrears rose to £16.9bn over the three months to June, leaping 28.8 per cent from the same period last year. 

While interest rates may have peaked, they remain much higher than in the past decade and are unlikely to fall any time soon. A house price recovery still looks a long way off.