What’s next for the UK housing market?

Covid-19 helped boost house prices in the UK, with demand for larger properties being particularly strong. The stamp duty holiday also played a role; as is the working holiday scheme, which protects consumer confidence. Rising inflation and the likelihood of higher interest rates bring new challenges.

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

Housing market activity has remained robust despite the stamp duty exemption ending September 30, 2021. The latest Halifax House Price Index report for April 2022 suggests that house prices rose by 10.8% year-on-year in April 2022. The average price of a house in the UK is now £286,079 – an increase of £47,668 on a year earlier . This is the tenth consecutive monthly increase, which is the longest streak since 2016.

Why have house prices gone up?

Home price inflation started to accelerate in late 2020. After the end of the nationwide lockdown in the first quarter of 2021, prices then increased significantly, with several factors contributing to this increase.

A lack of discretionary spending opportunities during lockdown helped boost household savings by around £200billion. This meant people could spend more savings on property post lockdown.

The increase in remote work led to greater demand for larger homes as people sought properties with additional rooms that they could use for offices. Halifax notes that in April 2022, single- and semi-detached house prices were up over 12%, compared to 7.1% for apartments last year.

The expansion of the working holiday program also helped boost income levels and confidence. And generally low interest rates, along with stamp duty holidays, made home buying cheaper during the pandemic.

Figure 1: Annual percentage change in UK house prices

Source: Office for National Statistics (ONS)

Central banks have also helped push house prices higher. The easing of monetary policy and the easing of the “countercyclical capital buffer” to 0% (which requires banks to hold a certain percentage of capital as a buffer during periods of high credit growth so that it can be released during a downturn as credit growth slows) to 0% prevented this during the pandemic a sudden tightening of financial conditions and encouraged banks to continue lending to support the recovery.

This further supported housing demand and pushed prices higher. In November 2020, mortgage approvals reached their highest level since before the 2007-09 global financial crisis and housing transactions through 2021 were above average levels for the pre-Covid-19 decade. Accordingly, total bank mortgage lending has increased during the pandemic (see Figures 2 and 3).

Low (and even negative) real interest rates since 2008 have helped push house prices higher. Planning restrictions and supply chain bottlenecks over the past year have also limited sourcing of key materials for construction. As a result, the supply of new homes remained tight and prices remained high.

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 provided mortgages during the pandemic-induced recession, including through the government-backed 95% Mortgage Scheme, which helps buyers secure a mortgage with a 5% down payment.

So the question is whether higher interest rates will lead to a sharp drop in home prices and defaults and a housing market crash. This is unlikely for four reasons.

First, there is expected to be only a gradual increase in the cost of borrowing, with the Bank of England’s Monetary Policy Committee expecting it to only raise its policy 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 to historical standards (and almost five times lower than before the global financial crisis). This suggests that credit growth has continued to be better controlled of late, which may have limited the accumulation of systemic risk amid rising housing costs.

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

Source: NMG

Figure 5: Debt to income ratio

Source: ONS, UK Finance

Third, in the period before and even after the pandemic, the share of high loan-to-value (LTV) and loan-to-income (LTI) mortgages has declined (see Figures 4 and 5). Likewise, the total household debt-to-income ratio (the ratio of borrowed debt to applicants’ income levels) and the mortgage debt-to-income ratio have remained stable throughout the pandemic period, at 10 to 20 percentage points lower than during the global one financial crisis.

This decline in the proportion of risky mortgage loans 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 tests for potential mortgages, with banks calculating applicants’ debt service ratios based on an interest rate three percentage points above the current interest rate.

At the same time, banks also face restrictions on the number of very high LTI mortgages they can offer: specifically, no more than 15% of new mortgages can have LTI ratios of 4.5 or higher.

This set of “macroprudential” measures has helped manage mortgage credit risks.

Figure 6: Share of housing loans to private individuals – according to Art

Source: Financial Conduct Authority

Fourth, the proportion of UK fixed rate mortgages has increased. These now account for 90-95% of all mortgages taken out by homeowners (see Figure 6).

These homeowners are already locked into a mortgage product that offers a fixed rate of interest for either two or five years, for example. This means that an increase in the interest rate will not immediately affect monthly repayments.

New mortgage applicants may be affected by higher interest rates, but once they set their interest rate as part of a fixed-term contract, they are cushioned from future changes.

On the other hand, owners of adjustable rate mortgages will experience higher monthly mortgage payments in line with higher nominal interest rates. Given that only 5% of mortgage holders use such a program, the impact of higher interest rates on these borrowers is unlikely to cause significant distress to the overall housing market.

Figure 7: Home loans to individuals

Source: Financial Conduct Authority

Another factor that will help prevent a housing market meltdown is the greater share of dual-income households and mortgage loans. Figure 7 shows that the number of mortgage loans to joint-income households has generally increased over the past decade.

Although there was a slight drop throughout 2021 (possibly because some people were reluctant to take the risk of buying mortgages and homes due to greater uncertainty about how the pandemic would affect their jobs and income) , they still make up 65% of the mortgages offered on the regulated mortgage market.

A household headed by two people with two sources of income should be better equipped to withstand higher living costs. The proliferation of this type of homeownership will therefore also reduce the likelihood of a large-scale default. It’s also possible that two employed and financially secure individuals are more confident about buying a home regardless of the current climate, further supporting housing demand and underlying prices.

How could the cost of living crisis affect tenants in rental apartments?

Homeowners and those with fixed rate mortgages are not the most vulnerable groups in this regard. The deepening cost of living crisis is likely to have a more direct impact on those who rent, live in assisted living or have borrowers with adjustable rate mortgage loans.

Landlords can increase rents when economic conditions change – for example, in response to rising utility bills or even lower house prices (see Figure 8).

In February 2022, the Royal Institute of Chartered Surveyors (RICS) reported that rental prices are expected to rise by an average of 4% across the UK over the next year. At a regional level, the survey suggests that in relatively low-income parts of the south-east of England and the East Midlands, rental growth will be limited by the deepening cost-of-living crisis.

Renters are more vulnerable to fluctuations in disposable income, which can affect budgeting (unlike fixed-rate mortgage owners, who can see their monthly payments for the life of their mortgage in advance). This means that rising 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 rents

Source: ONS


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

The prospect of higher nominal interest rates could slow strong growth in house prices and demand later this year when mortgage rates rise. But the Bank of England’s hike in interest rates from around 1% this year to 2.5% next year is unlikely to result in a collapse in house prices, especially as interest rates are gradually hiked.

The rising cost of living — which is putting pressure on disposable income — combined with record-high home price-to-disposable income ratios, are more likely to hit those with a rental home or an adjustable-rate mortgage than those with fixed-rate mortgages.

The higher cost of living may even discourage potential homeowners, especially single applicants, from taking risks, especially if they are forced to ditch savings to deal with the higher cost of living. This, in turn, can dampen demand for new homes and slow price growth.

Where can I find out more?

Who are experts on these questions?

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

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