What’s Next for the UK Housing Market?

Why have UK house prices increased rapidly over 2021 and 2022?

Several factors contributed to this rapid increase in house prices. A lack of discretionary spending opportunities during the periods of lockdown helped to boost household savings by around £200 billion. This meant that people had more savings to spend on property once lockdown was over. The increase in remote working led to greater demand for larger houses, as people looked for properties with extra rooms that they could use for offices. Halifax suggests that in April 2022, prices for detached and semi-detached houses had increased by over 12%, compared with 7.1% for flats, over the past year. The extension of the job furlough scheme also helped to support income levels and confidence. And the generally low interest rates, together with the stamp duty holiday, made buying a house cheaper during the pandemic.

Central banks have also played a part in driving up house prices. The loosening of monetary policy and the relaxation of the ‘countercyclical capital buffer’ during the pandemic prevented a sudden tightening of financial conditions and encouraged banks to continue lending to help the recovery. This further supported housing demand, pushing up prices. In November 2020, mortgage approvals reached their highest level since before the global financial crisis of 2007-09, and housing transactions through 2021 were higher than the average levels seen in the decade before Covid-19. In line with this, there has been an increase in total mortgage lending by banks throughout the pandemic. Low, and even negative, real interest rates since 2008 have helped to boost house prices. Planning restrictions and supply chain bottlenecks over the past year have also limited the procurement of key materials for construction. This has had the knock-on effect of keeping the supply of new homes tight and prices elevated.

With interest rates likely to increase over the coming months, are we going to see a large fall in UK house prices and increase in mortgage defaults?

I think this is unlikely for four reasons:

1. It is expected that there will only be a gradual increase in borrowing costs, with the Bank of England’s Monetary Policy Committee anticipated only to increase its policy interest rate from 1% to around 2.5% next year.
2. Household credit growth in the three months to June 2021 was 3.7%. This is higher than the 2019 average of 2.8% but still low compared with historical standards and almost five times lower than before the global financial crisis. This suggests that, lately, credit growth has continued to be better controlled, which may have limited the accumulation of systemic risk as housing costs rise.
3. In the period before the pandemic and even following it, the proportion of high loan-to-value (LTV) and loan-to-income (LTI) mortgages has fallen. Likewise, household total debt-to-income ratios and mortgage debt-to-income ratios have remained stable throughout the period of the pandemic, and they are 10-20 percentage points lower than during the global financial crisis. This fall in the proportion of risky mortgage lending since the financial crisis has limited the build-up of financial vulnerabilities. In June 2014, the Bank of England’s Financial Policy Committee introduced more thorough affordability checks on potential mortgages, with banks calculating the debt service ratios of applicants based on an interest rate that is three percentage points higher than the current rate. At the same time, banks have also faced limits on the number of very high LTI mortgages they are allowed to supply: specifically, no more than 15% of new mortgages can be at LTI ratios of 4.5 or greater. This set of ‘macroprudential’ policies has helped to manage mortgage lending risks.
4. There has been an increase in the proportion of fixed rate mortgages in the UK. These now account for 90-95% of total mortgages taken out by homeowners. These homeowners are already tied into a mortgage product that offers, for example, a fixed rate of interest for either two years or five years. This means that an increase in the interest rate is not going to have an immediate effect on their monthly repayments. New mortgage applicants may be affected by higher interest rates, but once they have had their rate locked in as part of fixed term deal, they will be cushioned from future changes. On the other hand, variable rate mortgage owners will experience higher monthly mortgage payments in line with higher nominal interest rates. But given that only 5% of mortgage owners are on such a scheme, it is unlikely that the impact from higher rates on these borrowers will cause significant distress across the housing market as a whole.

Another factor that will help to prevent a meltdown of the housing market is the greater proportion of double income households with mortgages. Even though there was a slight reduction throughout 2021, they still account for 65% of the mortgages supplied in the regulated mortgage market. A household managed by two individuals with two sources of income is likely to be better equipped to cushion themselves against higher living costs. The prevalence of these types of homeowners will therefore also reduce the probability of large-scale default. It is also possible that two employed and financially secure individuals may be more confident when purchasing a house, irrespective of the current climate, further supporting housing demand and underlying prices.

What about people in rental accommodation?

The worsening cost of living crisis is likely to have much more of a direct impact on those renting, rather than outright homeowners and those with mortgages. Landlords can increase rental rates as economic conditions change – for example, in response to rising utility bills or even in the wake of lower property prices. In February 2022, the Royal Institute of Chartered Surveyors (RICS) reported that over the next year, rental prices are forecast to increase by 4% on average across the UK. On a regional basis, the survey suggests that in relatively lower-income parts of the Southeast of England and the East Midlands, rental growth will be limited by the worsening cost of living crisis. Rental tenants are more susceptible to fluctuations in disposable incomes, which can affect budgeting (unlike fixed rate mortgage owners who have clear foresight of their monthly repayments for the term of their mortgage). This means that surging food and energy prices are more likely to hit renters, reducing demand for rental properties rather than residential properties.