Are Higher Mortgage Rates Really Here To Stay?

high mortgage rates

The Bank of England has raised rates six times this year, from a record low of 0.1% in December 2021 to more than 2.25% today. This flurry of rate increases is making borrowing costs more expensive for homeowners. Every month, they must allocate more of their income to paying interest on their mortgage costs. 

Raising Rates: It’s Not That Simple

Economists, media, and the general public expect the Bank of England to continue raising rates well into next year and possibly beyond, perhaps to 6% or more. That’s because the UK is in the worst inflation crisis since the 1970s. According to the Office for National Statistics, consumer prices rose 8.6% in the 12 months to August 2022, the highest in over forty years. 

However, economic conditions are different today back then, and they make extreme rate rises unlikely. Record debts and sky-high home prices mean that the bank’s scope for raising interest rates is limited. 

In 1975-76, the Bank of England set interest rates at 15% in an attempt to get inflation under control. Massive rate rises were the only option to avoid a Sterling crisis as oil prices spiked. 

However, in that era, debt-to-GDP was about half of what it is today. And the size of mortgages relative to income was also lower.

That changed, though, during the latter part of the 1970s and 1980s. House prices rose significantly above the consumer price index requiring buyers to take out increasingly large home loans, with the trend accelerating since the 1990s. Today, we’re standing right at the peak of house prices. They are currently higher than they have ever been before, both in nominal and inflation-adjusted terms. 

The Bank Of England’s Choices Are Limited

This puts central bankers at the Bank of England in a sticky situation. If they raise interest rates to 6, 8 or 12% next year to get inflation under control, they run the risk of making mortgages unaffordable. Buyers won’t be able to take out loans and house prices will collapse. 

Banks will respond by repossessing the properties of those who can’t pay their bills on time. But because prices are falling, they won’t be able to recoup their losses, and we could head right back into a 2008-style financial crisis, or worse. 

On the other hand, if UK central bankers don’t raise rates, inflation will continue to worsen. Holders of cash will see their wealth evaporate, prices will go higher, and standards of living will fall in the short and long term. Sterling will have a degraded status on international markets. And UK consumers will find it much more expensive to import goods and services from overseas. Civil unrest and greater political upheaval could follow. 

As a homeowner, you have to decide which of these two options is most palatable to the Bank of England. Do you think they will raise rates further and crash the housing market and financial system? Or will they allow inflation to run its course, perhaps for a decade or more? 

If you believe they will raise rates, the best strategy is to pay off as much of your mortgage as possible today. But if you think they’ll allow inflation to run rampant, then it makes sense to borrow as much as possible. A falling pound will reduce the real value of your mortgage and, potentially, increase your home equity via house price appreciation. hig