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House prices and fixed vs variable mortgage rates

It was May last year when we saw the Bank of England increase the base rate to 1%, the first time in 13 years since it was at this level. Over the next 7 months it was increased a further 5 times and now sits at 3.5%. The reaction by lenders, however, was far more aggressive with rates increasing to well over 5%. Why was this? The fixed-income markets that trade overnight swap rates (these are the rates lenders pay to hedge their risk against future fixed-rate mortgages) believed the base rate would rise and peak at 5.75% and were pricing rates accordingly. In other words, lenders’ rates were being increased well in advance of the Bank of England voting to increase the underlying base rate.

Since then, the curators of the mini-budget are gone, and all the indicators are pointing to inflationary pressures easing.

The result is that markets have adjusted their expectations of the base rate peaking to 4.25% in Spring of 2023, fixed rates have been slowly reducing and variable rates which track the base rate and are therefore lower but increasing are slowly converging towards the reducing fixed rates. We would expect mortgage rates to start settling somewhere between the current variable rates of around 4% and fixed rates of around 5.5%.

What about house prices?

If inflation and interest rates were a fire and we were stuck in it, then the mini-budget was the big front door opened by Truss and Kwarteng which oxygenated it. Their noble efforts to rescue us forced Buyers and existing homeowners to pause and consider their options and next move carefully.

Demand from buyers fell by 20% in October, with First-Time Buyers the most hesitant with a 26% fall in demand. Furthermore, over one in four landlords are now thinking about selling properties as they struggle to maintain a positive cash flow after taking into account rising mortgage rates, increased tax liabilities, and stricter EPC requirements. It is also worth considering seasonal trends, with this time of year often the quietest for property enquiries.

The Bank of England won’t start easing on rates until there is clear evidence that inflation has reduced and will remain on a downward trajectory. Until then, mortgage rates will remain in the 5% region, demand will remain dampened and house prices will gradually decrease.

Predictions are as accurate as a broken clock, can be right if you’re looking at the right time but most likely to be wrong. Forecasts are as dispersed as those for equity markets, nevertheless, people are interested in them and so we have gathered some of the leading predictions from across the property industry to give an £ example of what this means to average house prices over the next two years:

While predictions are likely to be inaccurate, what we can do is use the financial crisis of 2008 as a reference point. During the crisis house prices fell 18.2%. The current crisis, notwithstanding its own challenges, is not of the same scale as the 2008 crash so is unlikely to suffer the same level of damage.

The most pessimistic of the predictions is a total fall of 11% over the next two years and a predicted average fall in prices across the UK of £31,977. Perspective is important here, however, since December 2021 prices increased £27,893 meaning that effectively 12 months of growth has been lost, hardly what you would call a crash, in fact, a loss that would make holders of other asset classes jealous.

Fixed or Variable?

When interest rates were at historic lows, the vast majority of borrowers fixed their mortgage rate for a period usually between 2 to 5 years. During this time, you knew what your monthly repayments would be and there was no risk of them increasing. Indeed, I have no doubt that those of earlier generations who have lived through periods of high-interest rates were always very aware that rates could only stay so low for so long and the days of cheap money would eventually come to an end. Those days are now here.

The main appeal of variable rates is that if interest rates reduce, so do your mortgage repayments, not a realistic possibility two years ago. However, with rates now much higher, we have seen a lot more interest and take up of variable rates over the past few months, particularly while they were significantly lower compared to fixed rates which had already priced in future base rate increases.

The two types of rates are now slowly converging and the difference between them is getting smaller which makes it harder to make a decision on which is the right choice for you. There are of course benefits and drawbacks to each and how these complement your own circumstances and future plans, will have the most bearing and influence when you make your decision.

All else being equal, fixed rates are currently more expensive, however, we can all probably appreciate that a degree of certainty carries a larger premium these days. Nevertheless, with the expectations of the Bank of England base rate being revised down, we anticipate they will continue to reduce to meet the rising tide of variable rates (provided the base rate doesn’t exceed 4.25%, which is what has been priced into existing rates). Furthermore, the inflationary pressures have started to reduce, peaking back in October, so we also anticipate the base rate could also start reducing but not until perhaps 2024 once there is reliable evidence that inflation has significantly reduced and will remain on its downward trajectory.

By Alex Johnston


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