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What next for the UK housing market?

Covid-19 helped to boost UK house prices, with demand especially strong for bigger properties. The stamp duty holiday also played a role; as did the job furlough scheme protecting wider consumer confidence. Rising inflation and the likelihood of higher interest rates bring new challenges.

In 2020, the average UK house price increased by 2.9% compared with the previous year. This accelerated to 9.3% in 2021 (see Figure 1). Several factors have helped to boost house prices, including low interest rates, greater demand for larger homes to accommodate remote working, and the UK government’s stamp duty holiday, introduced in July 2020.

Activity in the housing market has remained robust despite the stamp duty relief ending on 30 September 2021. The latest Halifax House Price Index Report for April 2022 suggests that house prices increased by 10.8% year-on-year in April 2022. This means that the average price for a house in the UK is now £286,079 – up by £47,668 from a year ago. This is the tenth consecutive monthly rise, which is the longest streak since 2016.

Why have house prices surged?

House price inflation started to accelerate at the end of 2020. Prices then rose significantly following the end of the nationwide lockdown in the first quarter of 2021, with several factors contributing to this increase.

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.

Figure 1: Annual percentage change in UK house prices

Source: Office for National Statistics (ONS)

Central banks have also played a part in driving up house prices. The loosening of monetary policy and the relaxation to 0% of the ‘countercyclical capital buffer’ (which requires banks to hold a specific percentage of capital as a buffer during times of high credit growth, so it can be released during a downturn when credit growth slows) 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 (see Figures 2 and 3).

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.

Figure 2: Total number of mortgage approvals and housing transactions

Source: Bank of England

Figure 3: Total outstanding value of residential mortgages

Source: Financial Conduct Authority

What about mortgages?

Commercial banks have supplied mortgages throughout the pandemic-induced recession, including through the government-backed 95% mortgage scheme, which helps buyers to secure a mortgage with a 5% deposit.

So, the question is whether higher interest rates will cause house prices to fall sharply and bring about defaults and a housing market crash. This is unlikely for four reasons.

First, 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.

Second, 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.

Figure 4: Proportion of different loan-to-value (LTV) ratios

Source: NMG

Figure 5: Debt-to-income ratios

Source: ONS, UK Finance

Third, 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 (see Figures 4 and 5). Likewise, household total debt-to-income ratios (the proportion of debt taken relative to the applicants’ income levels) 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.

Figure 6: Proportion of residential lending to individuals – by type

Source: Financial Conduct Authority

Fourth, 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 (see Figure 6).

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.

Figure 7: Residential loans to individuals

Source: Financial Conduct Authority

Another factor that will help to prevent a meltdown of the housing market is the greater proportion of double income households with mortgages. Figure 7 shows that there has been a general increase in the number of mortgages supplied to joint income households over the last ten years.

Even though there was a slight reduction throughout 2021 (potentially because some people were more reluctant to take on the risk of purchasing mortgages and houses because of greater uncertainty around how the pandemic would affect their employment and income), 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.

How might the cost of living crisis affect tenants in rental accommodation?

Outright homeowners and those with fixed rate mortgages are not the most vulnerable groups in this context. The worsening cost of living crisis is likely to have more of a direct impact on those renting, those in sheltered accommodation or borrowers on variable rate mortgages.

Landlords can increase rental rates as economic conditions change – for example, in response to rising utility bills or even in wake of lower property prices (see Figure 8).

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 South East 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.

Figure 8: Annual growth in UK private rental prices

Source: ONS


Looking ahead, in the short term, increased demand for larger residential homes, together with tight supply because of planning restrictions, will continue to support UK house prices.

The prospects of higher nominal interest rates may start to slow the strong growth in house prices and demand towards the end of this year, as mortgage rates rise. But the increase in the Bank of England’s policy rate from around 1% this year to 2.5% next year is unlikely to lead to a collapse in house prices, especially as interest rates will be raised gradually.

The surging cost of living – which is squeezing disposable incomes – together with record high house price-to-disposable income ratios are more likely to affect those in rental accommodation or with variable rate mortgages compared with fixed-term mortgage holders.

The higher cost of living may even discourage risk-taking by prospective homeowners, particularly single applicants, especially if they are forced to run down savings to help to cope with the higher cost of living. This may in turn depress demand for new housing, slowing down price growth.

Where can I find out more?

Who are experts on this questions?

  • Barry Naisbitt
  • Paul Cheshire
  • David Miles
  • Geoff Meen
  • Christine Whitehead
Author: Urvish Patel
Photo by Andrew Michael from iStock
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