The Daily Telegraph - Saturday - Money
‘Trouble ahead’: inflation spike will hit homeowners
Bank of England reaction to tackle rising prices will come at a bad time for the housing market, says Melissa Lawford
Aspike in inflation may feel like a distant problem but homeowners must take note. Rapidly rising prices will force the Bank of England to raise the Bank Rate from its record low 0.1pc later this year, with a series of further rises anticipated in 2022.
Mortgage costs would go up significantly just as record house price growth has hampered Britons’ ability to afford a new home. In short, it would trigger the end of the house price boom.
RATE RISES WOULD HAMMER AFFORDABILITY A homeowner spends 38pc of the median income to service an 80pc mortgage on an average priced home with the Bank Rate at 0.1pc – or £827 per month, according to Capital Economics consultants.
If it rose to 0.5pc, and this was immediately passed on to mortgages, monthly costs would rise to £881, or 40.3pc of disposable income. Lenders would likely absorb some of the increase and monthly costs would rise to £832 – still roughly 38pc of income.
However, at 1.5pc, monthly mortgage costs would jump £100 to £932, equivalent to 42.6pc of median earnings. If the rise was passed entirely to borrowers, the share would hit 45pc. Both scenarios mean homes would be more unaffordable than any point since 2008.
An rise to 3pc would mean a £200 jump in repayments, even if it was partially absorbed by the banks. This would represent 47.5pc of earnings.
THE ROLE OF GROWING HOUSE PRICES The last time mortgages were so expensive, homes were cheaper in relation to earnings. In the last three months of 2008, the average house cost 6.3 times average earnings. Today, it costs 7.4 times.
Record house price growth following the pandemic has meant the value of homes is more out of kilter with wages than at any other time in the past 14 years. Normally, this would limit house prices but record low mortgage rates have boosted the market. In real terms, homes are exceptionally cheap to buy.
Yet if rates rise significantly, buyers will no longer be shielded from reality and buying power would evaporate.
This would come at a bad time for the housing market. The artificial incentive of the stamp duty holiday has come to a halt. Record house price growth has started to hit affordability and the Help to Buy scheme is winding down.
Simon Rubinsohn, of the Royal Institution of Chartered Surveyors, a trade body, said there was no momentum in the market. An interest rate increase would further dampen sentiment, though a rise would have to be significant to trigger any significant change to house prices, Mr Rubinsohn said. “If the Bank Rate hit 2pc to 3pc, it would be a shock,” he added.
THE SPECTRE OF FORCED SELLERS Meanwhile, existing homeowners would suddenly find their mortgages were unaffordable. Andrew Wishart, of Capital Economics, said: “When mortgage payments get into the high 40s as a percentage of median income, it usually spells trouble ahead.”
A Bank Rate rise to 2pc would bring mortgage rates of around 4pc and trigger a jump in households struggling to repay their mortgages, said Mr Wishart.
Restrictions on lending and affordability criteria in the wake of the financial crisis have meant that the British property market has improved safeguards.
Before the crash, one in six borrowers only had 10pc equity in their home, Mr Wishart said. That has dropped to 3pc. “As a result, homeowners have more skin in the game and a bigger incentive to keep up mortgage repayments.” Stress tests are also much more rigorous making repossessions less likely.
Nonetheless, higher rates could coincide with a sharp slowdown in the economy, leading to job losses. “That would cause some borrowers to fall into arrears and repossession would rise even if they have a significant equity stake in the house,” he said.
BRITISH HOMEOWNERS WOULD BE HIT HARDER Rate rises pose a bigger risk to the British housing market than in other countries such as America because a larger share of homeowners here are on variable-rate mortgages, said Vicky Redwood, of Capital Economics.
Variable-rate mortgages are periodically adjusted according to what the Bank of England does, meaning increases would quickly translate into higher costs for homeowners.
Coupled with rapidly rising household bills, this could put pressure on affordability and, in turn, increase the likelihood of forced sellers.
However, British homeowners have grown to prefer fixed-rate mortgages. in recent years. Between April and June this year, only 6pc of new mortgages issued in Britain were on a variable basis. That is lower than the 44pc recorded in July 2012, and is now much closer to the American level of 3.6pc. But the crucial difference is that British homeowners take out much shorter deals – usually between two and five years compared with 30 years in America. Because of the shorter terms, one in five mortgaged homeowners in Britain have a variable-rate contract; in America it is one in 20.
Problems of affordability will be seen much faster in Britain than in America, Mr Wishart said.
Homeowners would suddenly find mortgages were unaffordable