Britain Faces Its Biggest Housing Crash on Record
The era of cheap money led to soaring house prices – now homeowners face a brutal reckoning
Claire Edwards and her husband John Marsh bought their £420,000 home in 2019, securing a five-year fixed mortgage at a bargain rate of 2.5%. But the era of cheap money is now coming to a brutal end for Britain’s homeowners. Edwards – and millions of other borrowers – are facing rate rises that to many will be simply unaffordable.
As a result, the housing market is in for a terrible reckoning – with some forecasters predicting that the impending mortgage catastrophe could trigger a crash the likes of which have not been seen since records began. Last month, Britain’s biggest bank Lloyds said prices could fall by as much as 35% in the worst-case scenario.
And now that the dust is settling on a grim picture for the housing market, economists say that this should all have been foreseeable – and even avoidable. More than a decade of unprecedented ultra-low interest rates was always going to come to an abrupt end.
Mortgage Shock
Mortgage rates surged again last week after unexpectedly strong wage data prompted traders to revise forecasts for interest rates. The Bank Rate is now expected to climb from its current level of 4.5 to 5.75% towards the end of this year, which lenders are now pricing into their mortgage deals.
The average two-year mortgage rate reached 5.98% on Friday, while five-year deals hit 5.62%, according to data analysts Moneyfacts. HSBC and Santander were also among banks that pulled deals from sale before reintroducing them at higher rates.
The lowest rate offered by Halifax has risen from 4.59% to 5.41% since May 24, when worse-than-expected inflation figures spooked the market into forecasting further increases from the Bank of England. The jump added an extra £100 to the monthly repayments of a homeowner with a £200,000 debt, according to broker L&C Mortgages.
On a Knife’s Edge
The sharp increase in the cost of mortgage borrowing has put house prices at risk of crashing by as much as 35.5% from 2023 to 2027, according to worst case scenario forecasts from Lloyds published in May. This would be the worst downturn since at least the 1950s. During the 2008 financial crisis, prices slumped by as much as 20%.
House prices have already fallen by 4%, according to lender Nationwide. And when inflation is taken into account, this represents a plunge of 13%, Capital Economics calculated.
Andrew Wishart, of Capital Economics, warns that their forecast is based on the Bank Rate peaking at 5.25%. Economists are keeping a close eye on volatile market predictions for interest rates.
Too Slow to Act
Experts say the mortgage repayment crisis Britain now faces was brought on by decisions made by the Government and the Bank of England. The Bank of England lowered interest rates to a record low of 0.1% in March 2020, where they remained until December 2021. The Bank Rate has had 12 consecutive increases and is now at 4.5%.
Andrew Goodwin, of Oxford Economics, says the UK was not alone in lowering interest rates during the pandemic. He says the economic impact of going into lockdown was so severe that the Bank of England had no choice.
Yet Britain currently has the highest inflation rate in the G7 group of developed nations. It is this persistent inflation that is expected to force the Bank of England to keep raising interest rates, piling costs on to homeowners.
The Pay Rise Problem
Data from the Office for National Statistics this week showed wages increased by 7.2% in the three months to April – a record outside of the pandemic. A tight labour market is giving employees the power to demand bigger salaries.
This rampant wage growth is creating what economists call a “wage-price spiral” that pushes up demand and therefore inflation.
High energy prices and food bills have also contributed to stubbornly high inflation over the past year. Heavily reliant on imported gas, the UK has been much more vulnerable to the economic impact of the war in Ukraine than some other countries with bigger domestic energy supplies, like the US and Canada, Neufeld says.
A Vulnerable House Price Bubble
However, its consequences have had big ramifications for homeowners.
Neal Hudson, of analyst BuiltPlace, says house prices have surged over the past 10 years because of low interest rates, which have allowed households to borrow ever-growing amounts of money. This was particularly pronounced during the pandemic, with house prices rising 18% in 2020 and 2021, according to Nationwide.
“We’ve got very high house prices relative to earnings,” he says. “People borrow large multiples of their income to buy homes. And unfortunately, that makes them more exposed to increases in mortgage rates.”
Housing affordability has fallen to the lowest level in 150 years, according to a report from the asset manager Schroders. House prices now stand at more than nine times the average salary, a ratio not seen since 1876, it said.
Pouring Fuel on the Fire
The Government has been accused of further stimulating house price growth by cutting stamp duty during the pandemic.
The tax break, which initially raised the nil-rate stamp duty band in England and Northern Ireland from £125,000 to £500,000, was in place between July 2020 and June 2021.
Economists also say that house prices were driven up by the Government’s Help to Buy scheme. The initiative, which closed to new applications last October, offered first-time buyers a loan worth 20% of the purchase price – or 40% in London – that was interest-free for five years if they purchased a new-build property.
While new builds are typically sold at a premium compared with resale homes, the gap increased while the scheme was in place, according to market analyst TwentyCi.
## Britain’s Short-Term Addiction
Homeowners are also vulnerable to a sudden shock in their mortgage repayments because most have short-term fixed mortgage deals.
In the US, the mortgage sector only functions as it does thanks to a long tradition of federal support through lenders Fannie Mae and Freddie Mac. For this reason, most Americans have 30-year fixed mortgage rates, leaving them less exposed to interest rate rises.
Mortgage brokers also have a financial incentive to promote two-year fixed mortgage deals. For each deal brokered, they usually get a commission, or procuration fee, from the lender worth around 0.35% of the loan, Hollingworth says. Many brokers also charge the buyer a commission fee of up to 1%.
Trouble Ahead
Most homeowners with cheap mortgages are going to be hammered by surging rates in the next few years. Just a third of borrowers that are on cheap fixed-term deals have reached the end of their term so far, according to Capital Economics, with millions more to come.
Around 145,000 homeowners are expected to fall into mortgage arrears, according to Capital Economics. In 2025, the number of homes repossessed will reach the highest level since 2014, according to Oxford Economics.
Those who want to sell their homes also face the prospect of falling house prices. Wishart warns that the plunge in house prices could be even worse than Capital Economics anticipated.
Meanwhile, Mosley says mortgage rates are unlikely to return to the levels seen in the past decade.
An Almost Inevitable Recession
The knock-on effects of high mortgage rates will also have significant repercussions on the British economy.
Economists are warning that a recession is increasingly likely. Capital Economics’ Ashley Webb says a recession is expected to start in the second half of this year and continue into early 2024. A peak-to-trough decline in real GDP of around 0.5% is forecast by the consultancy.
Even when the economy recovers in 2024, growth is still expected to be below pre-pandemic levels. From 2010 to 2019, growth was 2% a year. The Capital Economics forecast for 2024 to 2026 is an average of 1.2% a year, which is partly because of cuts to interest rates.
In the meantime, Britain’s borrowers are bracing themselves for what is to come. The era of cheap money led to soaring house prices, but now homeowners face a brutal reckoning as rates rise. The coming years will test their finances like never before.