How Are Interest Rates Affecting Mortgages?

There are 25 million-plus homeowners in the UK with a mortgage. Repayments for these mortgages can take a hefty slice out of their budget.

Higher interest rates have been pushing up the cost of mortgages. This is despite a fall in house prices.

In this post, we look at the connection between inflation, interest rates, and mortgages.

How and Why Are Interest Rates Set?

Interest rates determine the cost of borrowing money. They also help set the rewards for savers. In the UK, the interest rate is set by the Bank of England (BoE). This benchmark or base rate is the most important interest rate in the UK.

It’s controlled by an independent group of economists within the BoE. They are called the Monetary Policy Committee. This group sets the Base Rate eight times a year.

In times of high inflation, the aim is to get banks and lenders to increase the rates they charge borrowers. This can help control inflation and influence the economy.

In 2009, the interest rate was reduced to just 0.5% as a response to the financial crisis of the time.

Since then, things have changed drastically. The Bank of England has increasingly raised the Bank Rate to try to curb soaring inflation.

Inflation, Bank Rate, and Mortgage Interest Rate

The rate of inflation and interest rates are linked. When inflation is high, the BoE often increases interest rates. They do this to encourage people to spend less and save more. In theory, this results in less demand for goods and services. That helps contain inflation.

This may be good news for those able to put aside some money for a rainy day, as they’ll usually earn more on their savings. But it’s a different story for borrowers. People like householders with a mortgage could see monthly repayments increase due to the higher rate of interest.

The UK has experienced a series of interest rate increases since December 2021. The Bank of England is trying to bring inflation down to 2%.

What Are Mortgage Interest Rates Doing Now?

When interest rates rise, banks typically respond by increasing mortgage rates. That means mortgages become more expensive.

In the economic upheaval that followed the September 2022 mini-Budget, the average mortgage rate exceeded the Bank Rate.

Many worried that homeowners could default on their mortgages because of the higher costs. Householders with a variable rate or tracker mortgages felt the pinch immediately. Those with a fixed-rate deal due to expire may have had trouble finding an affordable new mortgage. But since then, mortgage rates have been falling. The consensus is that they’ll continue to decrease gradually throughout 2023.

How Do Higher Interest Rates Affect My Mortgage?

How rising interest rates impact your mortgage depends on the type of mortgage you have. A tracker mortgage will go up or down in line with changes in the base rate.

Variable mortgage deals may go up if the Bank Rate does. But this is up to the lender’s discretion.

If you have a fixed-rate mortgage, you won’t see any change until the fixed rate period ends.

The Connection Between Mortgage Rates and House Prices

House prices have been falling in recent times. This is caused by higher mortgage costs due to rising interest rates.

When mortgage prices go up, fewer people can afford to buy. Towards the end of last year, the number of mortgage approvals dropped by 20%.

With fewer buyers around, sellers might have to reduce the asking price of their homes. According to Nationwide Building Society, in the 12 months to February 2023, the price of homes dropped 1.1%. That is the biggest annual decrease since 2012.

The Office for Budget Responsibility (OBR) predicts house prices will fall 9% over the next two years. They predict prices will not start to increase again until 2025.

What Does the Future Hold for Mortgage Rates?

Rising mortgage payments can hit existing homeowners’ budgets hard. They also made it more difficult to buy a first property. Add the cost-of-living crisis and mortgages were bound to be affected.

Even a small increase in the Bank Rate can mean higher mortgage costs. For example, the 0.5% rise in February 2023 translated to an extra £672 a year on a £200,000 25-year tracker mortgage.

Navigating the mortgage maze in a fluctuating property market can be confusing but one thing’s for sure.

Although mortgage rates may be falling in 2023, homeowners and first-time buyers will continue to keep a close eye on how interest rates will affect mortgages in the future.