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Will the latest interest rate rise trigger a housing market crash?

With interest rates rising at their fastest pace in 27 years, inflation tipped to hit 13% later this year, and a recession looming, is the housing bubble about to burst?

The housing market has remained remarkably resilient in the past six years, withstanding severe economic headwinds posed by Brexit, the coronavirus pandemic and the ongoing cost of living of crisis. Recent growth in the space has been particularly eye catching, with the average UK home value rising more than a fifth since mid-2020. However, there are signs this run is about to end with the property market set to face its sternest test since the 2008 global financial crisis.

The Bank of England (BoE) has increased interest rates by 0.50 percentage points on two occasions in the past two months to currently stand at 2.25%  -their highest point since 2008.

Laying out its reasoning for taking such a heavy-handed approach, the UK’s central bank cited rocketing inflation, which is forecast to rise even higher in autumn. Furthermore, the BoE also warned of further rate rises, which financial markets predict could hit 6% next year.

Given that whenever interest rates rise, borrowing becomes more expensive, the housing market will be affected in some shape or form. But the question is, will this recent measure prove the tipping point for prices to finally come crashing down?

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Slowdown emerging

The bleakness of the economic outlook suggests challenging times ahead. However, the housing market has frequently defied expectations. In June 2016, when the UK voted to leave the EU, many predicted the ensuing economic uncertainty would force property valuations downwards. But just over half a decade on, the average UK house price has climbed from £213,000 to £281,000.

As mentioned above, a large chunk of this growth has occurred since 2020. Not even a global pandemic - including a recession, albeit a brief one - and Russia’s invasion of Ukraine resulting in rocketing energy, food and petrol prices has been enough to stop house values surging to record highs.

The mood, however, has started to change, with signs the market is beginning to cool. According to Halifax data, house prices dipped 0.1% between June and July, arresting 12 consecutive months of growth.

And experts feel this may prove a trend rather than a short-term anomaly. In May Capital Economics predicted UK house prices will drop 5% over the next two years. More recent warnings suggest the fall could be as much as 15%.

Interest rates on the up

Interest rate rises have hogged their fair share of column inches this year. The UK’s base rate has gone up seven times since December, climbing from 0.1% to 2.25% in the process.

Last week's rate rise will place a further squeeze on your household finances, which are already under pressure from the cost of living crisis.

The BoE's move followed similarly aggressive fiscal activity on the other side of the Atlantic. Also last week, the US Federal Reserve announced a 0.75 percentage point interest rate increase in a bid to curb rising inflation, which like the UK, is currently north of 8%.

The recent uptick in interest rates is impacting both current and budding homeowners. With fixed-rate mortgage deals significantly less attractive than they were just a few months ago, many first-time buyers will be priced out of homes that were previously affordable.

Those of you on variable rate and tracker mortgages will feel the pinch immediately, but aren’t the only ones being affected. Anyone with a fixed-rate deal due to expire soon may find it difficult to secure a similarly favourable rate, and so will see your monthly repayments increase when you come to remortgage.

Will the market crash or cool off?

Housing markets in other parts of the world are looking increasingly fragile. The Bank of America recently said the US market is already hitting the brakes, while Australian property values have dropped 2% since May.

But while the annual double-digit growth that the property market has enjoyed over the past couple of years looks unsustainable, a crash still appears some way off. The most likely short-term outcome is for prices to start levelling off.

A key factor for the recent spike in property valuations has been limited supply and strong demand. The resulting bidding wars has meant many homes have fetched well above their initial asking price. And this supply shortage remains, especially with the government continuing to fall short of its annual new homes target.

Would a crash be welcome?

This very much depends on your situation. Those of you who have bought houses recently will be hoping a crash is avoided as tanking property values runs the risk of negative equity – particularly if your loan to value ratio is high.

Some of you, however, would benefit from the property bubble bursting. You may even want it to happen given the speed at which house prices continue to outpace wages.

Most lenders cap borrower affordability at 4.5 times income, but data from the Office for National Statistics found that the average home is now 8.7 times higher than average wages. If house prices experience significant falls, you may be able to get a foot on the ladder many years sooner.

To plug the gap between prices and wages, prospective homeowners are having to save harder and for longer to amass the size of deposit needed. Or for those fortunate enough, your parents may step in to help. This is a growing trend - the Bank of Mum and Dad is now the tenth biggest mortgage lender in the UK.

Though one possible drawback here is that some elders may be sacrificing their own retirement plans to financially support their offspring.

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Is now a good time to buy?

Timing any market, whether it involves property or other assets such as stocks and shares, can be risky, and largely should be avoided. The housing market’s unpredictability over the past few years offers a case in point.

Whether now proves the right time to buy hinges on several variables. There is every chance that interest rates could climb even higher, especially if inflation lives up to predictions. And as we know, as rates go up, mortgages become more expensive.

It’s also worth remembering that, unless you’re looking to buy and move within say the next couple of years, property should be viewed as a long-term commitment.

If you find a home that you want and after some careful calculations decide the repayments are affordable, the prospect of a crash is unlikely to put you off.

What to do next?

While no one can predict the future, knowing where you stand right now is a great place to start. This where taking some professional advice can prove invaluable. If your current fixed deal is due to expire soon and you’re concerned about how this might affect your monthly outgoings, a mortgage adviser can bring some much-treasured peace of mind.

The same applies if you’re a prospective first-time buyer and are unsure about how the rate rises will affect your affordability. An expert mortgage professional can search the market to find the best deal for your individual circumstances.

If you found this article helpful, you might also find our latest news piece on mortgage rates informative, too.

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About the author
Craig Rickman is senior content writer at unbiased.co.uk. He has been writing about personal finance and wealth management since 2016, including four years as a journalist at the Financial Times Group. Prior to this, Craig spent eight years working as a regulated financial adviser. He holds the CII level 4 Diploma in Financial Planning.