We’re all feeling the pinch of rising prices. You only have to look at the price of your food shop or your energy bill to see the impact of inflation on your household spending – but how does inflation affect mortgage rates?
While inflation fell to 9.9% in the year to August, it rose again to 10.1% in the 12 months to September according to the Office for National Statistics (opens in new tab). It is expected to peak at 11% and then begin to fall in early 2023, according to the Bank of England.
We explain how rising inflation impacts mortgages, what worried mortgage holders can do now – and whether inflation could cause house prices to fall.
How does inflation affect mortgage rates?
When inflation rises like it has this year, it can have a significant impact on mortgage rates. This is because the Bank of England looks at factors like inflation when deciding whether to raise or cut the base rate. A rise in interest rates is what then affects mortgage rates. Some homeowners could see an increase in their monthly repayments, while first-time buyers will see mortgage rates get higher and affordability tests harder to pass.
The UK inflation target is 2%, so anything above this increases the chances of the Bank of England hiking interest rates to bring inflation back under control. The opposite is true if inflation is very low. In that case, interest rates may be cut to try and get people spending rather than keeping their money in savings.
Faced with soaring inflation, the Bank of England has responded by raising interest rates multiple times this year. Since January, the base rate has increased from 0.25% to it’s current level of 3%.
Laura Suter, head of personal finance for fund supermarket AJ Bell, says: ‘Further interest rate rises are predicted this year and into next year with the expectation being that rates will hit 3.75% by the end of this year and peak at around 4.5% next autumn. That means mortgage rates are expected to rise far more from here.’
Is high inflation good news for homeowners?
Unfortunately, high inflation is rarely a good thing for those with mortgages. If interest rates subsequently rise, this pushes up mortgage rates too. But not everyone will see an instant increase in their monthly repayments. How quickly the rise is passed on to you depends on the type of mortgage you have.
If you have a fixed rate mortgage, you won’t see the impact of an interest rate rise until the end of your fixed-term and you remortgage or move on to your lender’s standard variable tariff. This is because your interest rate is locked in for the duration of your fixed term. But when you come to remortgage, it’s likely that you will have to pay a higher rate on your next mortgage if the Bank Rate remains high.
However, those homeowners who are on standard variable rates or have tracker mortgages will usually see an increase to their monthly payments as their rate is tied to the base rate and can go up or down each month.
What should I do about my mortgage if I’m worried about inflation?
It can be a worrying time for homeowners when inflation rises. Alice Haine, personal finance analyst at BestInvest says: ‘High inflation is the enemy of household finances, as it slashes spending power and erodes savings, making it very hard for people to maintain their living standards.’
Those on a fixed rate should double check when their current deal ends and add a reminder to your calendar for when you should start looking for a new deal. Some banks and building societies will let you lock into a new rate between three to six months before your old one expires.
Laura says: ‘Those remortgaging who feel like they can’t afford a new, higher monthly amount could choose to extend the term of their mortgage. This will cost more over the long-term but could provide them with breathing space for now.’
Another option is to switch to an interest-only mortgage whereby you only repay the interest each month and none of the debt. This will reduce your monthly payment but your mortgage balance will not go down. ‘Interest only isn’t a great long-term solution for lots of homeowners, but it could provide the short-term relief that some borrowers need,’ adds Laura.
If you’re on an SVR – which is the most expensive type of mortgage rate – you could save hundreds, maybe thousands, of pounds a year by moving to a fixed rate. Speak to a mortgage broker if you need help searching for a new product, or if you’re unsure about your options.
If you are struggling to afford your monthly payments, read our guide to what to do if you can’t pay your mortgage to find out what help is available.
Should I pay down my mortgage during high inflation?
It’s always a good idea to overpay your mortgage – if you can afford it. During the cost of living crisis, this may not be possible as just paying your usual mortgage bill, plus other essential expenses, can feel like a stretch.
For other homeowners, you may feel you can comfortably overpay your mortgage (perhaps you have a large amount of savings, and a decent salary with good job security).
Sarah Coles, personal finance expert from Hargreaves Lansdown, says: ‘At a time of high inflation, if you pay down your mortgage then the higher rate of interest you are being charged will be applied to smaller amount of mortgage debt, which makes it more affordable.
‘It may not be your first priority, but if you’re already on top of more expensive short-term debts and you have enough emergency savings it’s certainly worth considering.’
By overpaying your mortgage you will also pay less interest over the life of your mortgage.
If you are able to pay extra, check if there is a maximum amount you can overpay on your mortgage. If you go over this limit, the lender could charge a hefty fee.
Is inflation good for house prices?
As interest rates rise, the housing market often slows down. However, house prices have been climbing this year, despite interest rates rising. But this stalled in October, according to the Nationwide House Price Index, which showed a 0.4% drop in house prices, when the steep increase in mortgage rates caused prospective homebuyers to approach the purchase with more caution than they may have done previously.
Alice adds: ‘The 0.4% monthly drop in house prices in October is to be expected when you consider the challenging borrowing conditions and general gloom clouding the economy right now.
‘With inflation at a 40-year high of 10.1%, interest rates at 3%, the economy slowing and the mortgage market still reeling from the effects of Liz Truss’s short tenure as Prime Minister, affordability is very much in the spotlight with buyers forced to confront whether now really is the right time to buy.
‘With expectations, prices could fall by as much as 30% in the next-year in a worst-case scenario, this offers some hope to first-time buyers. However, mortgage rates are still stubbornly high at around 6.5% despite the BoE’s lower interest rate expectations of a peak between 3 to 4% next year.
‘While existing homeowners coming to the end of fixed-rate deals are facing monthly repayments hundreds of pounds higher, those looking to buy who are patient and put plans on pause may see better deals coming down the line.’