Yahoo Finance Home owners brace for years of falling prices as mortgage costs jump
“House prices are about to crash”– you've probably heard it a million times. Predictions of apocalypse in the property market are ten-a-penny in a country where the cost of a home routinely hits another record high.
Prices even seem to climb at the least likely moments. The pandemic was a case in point. Back in early 2020 it seemed obvious that a record-breaking recession would cause a collapse in the market.
Yet the opposite happened – prices were pushed up by fresh cuts to interest rates combined with unprecedented support for jobs and a lockdown which forced the home-working population to re-evaluate its living conditions. Even crowded and apparently unappealing London managed to turn three years of plateauing prices into a new growth spurt.
The latest official data shows the average UK home cost £277,000 in February, up £27,000 or almost 11pc on the year – meaning the typical property “earned” around as much as the typical worker.
This is faster than the price growth of the months before the financial crisis.
There are now reasons to think that the market is beginning to turn, and they are founded on something rather more solid than a gut feeling.
Fundamental to price growth in recent years has been record low interest rates.
Cheap borrowing lets buyers bid ever-higher for a property while keeping monthly repayments low. This has also been accompanied by an extension in loan terms, which have crept up from the traditional 25-year mortgage to 30 years or more.
However, inflation is now rampaging to levels not seen since the early 1990s, and the Bank of England is responding by lifting interest rates.
Andrew Bailey, the Bank's Governor, and his colleagues on the Monetary Policy Committee have raised interest rates from 0.1pc in December to 0.75pc now.
Policymakers are expected to hike rates to 1pc next week, with financial markets anticipating steady rises to 2.5pc over the next year.
Analysts at Capital Economics expect rates to peak at 3pc.
This is low by historic standards, but is far and away the highest level since the financial crisis struck nearly 15 years ago.
It means an entire generation of borrowers will be exposed to a rate rise the likes of which they have never seen before – coming at the same time as inflation delivers the biggest squeeze on real household incomes since records began in 1956.
Andrew Wishart at Capital Economics expects the interest rate on new mortgages to rise from 1.6pc at the start of this year to 3.6pc by late 2023.
A sharp increase of two percentage points has not happened since 1990 – after which came a painful crash in the housing market. Prices dropped for four straight years and only really started to recover from 1996.
This time around, Wishart expects prices to keep rising for the time being before levelling off at the end of the year and turning down to drop 3pc in 2023 and 1.8pc in 2024.
“Visits to property websites dropped back to their lowest level since May 2020 this month, and the RICS housing survey suggested that quarterly house price growth will cool to zero by the third quarter,” he says.
This does not mean a crunch like that of the 1990s, however.
Even if the average new mortgage does rise to 3.6pc, that is far short of the almighty 17pc peak in 1990, or even the standard pre-credit crunch levels of 5pc to 6pc.
Wishart expects rates to start falling again in mid-2024.
Fixed-rate mortgages had barely been invented by 1990, with borrowers typically trotting off to the local bank or building society branch to pay a different bill every month as interest rates rapidly changed.
Now, most buyers opt for a five-year fix, locking in low rates for years to come.
As a result, most of the impact of higher borrowing costs will be felt either by new buyers or by those whose fixed terms happen to come to an end as rates peak – an unfortunate minority, rather than the majority who suddenly found monthly payments spiralling more than 30 years ago.
Even people whose fixed deals expire might not feel the full effect. A homeowner whose five-year fix comes up could easily find the rise in their property’s value over that period puts them in a better loan-to-value bracket, giving them access to cheaper finance.
Meanwhile, unemployment started the 1990s at around 7pc, climbing to above 10pc – a peak of more than 3m people – in 1993, leaving many families unable to pay the mortgage.
By contrast the jobless rate now is 3.8pc, its joint-lowest since the mid-1970s, and employers have a record 1.3m job vacancies available. All of this supports households’ ability to keep paying the bills even as interest rates rise.
Simon Rubinsohn, chief economist at the Royal Institution of Chartered Surveyors, says “some slowdown seems inevitable”, but so far there are few signs of “buyers are being put off”.
“If you think back to major downward adjustments in the market, it has been associated with major recessions where you have had very sharp rises in unemployment and the result of that has been distressed sales of property,” he says.
“At this point even the recession that some people are beginning to think about is not on that scale. Unemployment remains low, employment remains high, [job] vacancies are hitting new highs. We seem at this point a long way from the sort of scenario we have seen perhaps in the early 1990s.”
Given the squeeze in the market would mainly affect new buyers, rather than forcing owners to become sellers, the effect of this crunch might not be a spiral down in prices.
Potential vendors could afford to hold off and wait for stronger demand to come back again.
“We are not expecting people to be forced sellers. Instead what we will probably see is transactions drop right off,” says Wishart, predicting house sales to drop from 1.2m before the pandemic and almost 1.5m last year to around 1m per year “reflecting a slowdown in the market and people choosing not to move when sentiment is against the market”.
