How does the latest interest rate rise affect mortgages?


On the 2nd February 2023, the Bank of England raised the base rate of interest by 0.5% to a total of 4%. This is the latest of 10 rises in the last year and represents the Bank’s latest attempt to combat inflation in the UK.

The base rate influences many other rates in the UK. Most importantly for the purposes of investors, it will affect the rate of interest charged for a mortgage.

By raising the interest rate as a means to bring inflation down from its current level of 10%, the Bank has acknowledged that the mortgage and property markets will be affected in the short term, possibly in a negative way.

However, the Bank believes that this is the best path for long-term, stable economic growth in the UK. It points to the fact that inflation has begun to edge downwards as proof that it is the right move. Current forecasts see inflation falling to 4% by the end of 2023 – much closer to the Bank’s target of 2%.

How have interest rate rises affected the mortgage market?

In the meantime, what effect has this had on the mortgage market? The short version is that the base rate determines the interest rate which the Bank of England pays to commercial banks, and in turn that influences the rates those banks charge people to borrow money or pay on their savings.

Over 2022, mortgage rates increased rapidly and topped 7% in some cases as a consequence of the Bank raising interest rates again and again. As the cost for banks to borrow went up, they passed that onto borrowers.

This hurt a lot of property investors. Firstly, those who were borrowing to buy a new property and expand their portfolio. Secondly, those who were remortgaging existing properties on variable rates which shot up unexpectedly.

In both cases, these increased mortgage costs negatively affected property yields, especially in cases where the rises could not be passed on to tenants in the form of increased rents.

For many, the question became one of whether they could afford to continue as a property investor or whether it was time to sell up. The latter became a difficult prospect in itself as house price growth stalled by the end of the year and in many cases the average property value even fell.


What does the future hold for mortgage prices following the latest interest rate rise?

Now, in 2023, the mortgage rate has risen again and it would be natural to fear further negative consequences as an investor. However, all might not quite be as it seems at first glance, and in fact there are indications that the worst may be over.

Ordinarily, and based on last year’s evidence, we would expect a rate rise to lead to more expensive mortgage products once again. However, it appears that lenders had already priced the possibility of such a rise into their existing products and there has been no sign of increased rates as a result – this is great news for investors using a mortgage.

Furthermore, after the latest Bank of England announcement, market expectations are that the likelihood of major rate rises again in the future has decreased. The Bank itself has indicated that rates have either peaked, or are close to doing so.

Overall market sentiment shows that traders may be anticipating a further rise of 0.25% at the end of March, but following that a loosening of economic policy may be on the way by the end of the year.

This change in expectations has led to a belief in the index swap market – which follows the Bank base rate decisions – that the average interest rate over the coming five-year period will decrease to 3.21%, down from the expected 3.93% which was predicted in January.

When it comes to the immediate and long-term effects on mortgages, expert opinion is positive. Mark Harris, chief executive of mortgage broker SPF Private Clients, said: “Should the Bank raise rates, base-rate-tracker mortgages will immediately adjust and variable rates are likely to follow.

“However, fixed-rate mortgages have been gradually falling in recent weeks and we expect this trend to continue as the market has already priced in a base rate rise.

“We expect five-year fixed-rate mortgages to fall below 4 per cent over the next few months and as inflation comes under control, expect a gradually reducing trend throughout the year with base rate reductions expected at the beginning of 2024.”

This prediction has already been proven correct with the likes of HSBC and Virgin Money offering five- and 10-year fixed-rate mortgage products at under 4% again for the first time since last August.

The rate for shorter-term, two-year products is also falling. Moneyfacts reports that the average rate on two-year fixed deals has dropped to 5.43%, from 5.77% at the start of the year.

Simon Gammon, managing partner at broker Knight Frank Finance, said borrowers would welcome a significant drop in the cost of two-year fixed mortgages, and added that the decision on whether to take out a five-year fix had become more challenging as the two-year rates are also looking more favourable.

“At the moment, five-year fixed rates are cheaper than two-year fixed rates,” said Gammon, “but a lot of people with uncertainty and those who don’t quite know when to fix are actually more interested in the shorter term deals.”

When can we expect further drops in the interest rate?

If rates peak at a maximum of 4.5% by the end of 2023 as expected by the markets, then the next phase will be a gradual fall and a period of stability as everything settles. The opinions of experts and indications from the Bank settle on this being around 3.25% for three years from the end of 2023.

This will be enabled by a sharp fall in inflation by the end of 2023. The Bank believes there will be three factors behind this. Firstly, the price of energy will stop rising so quickly. Secondly, the prices of imported goods will therefore stop rising as fast as they have been. Thirdly, the Bank expects that this will equate to comparatively less demand for UK goods and services.

It is likely that mortgage rates will continue to track downwards over this period of time along with inflation and the base rate. This is good news in general for property investors – and it also suggests a particularly effective strategy for investing which may give you the best results.

By investing off-plan while a development is still in construction, it may be possible to secure a property for a 2023 price – at a time where property values have fallen slightly – and get a more favourable borrowing cost in the future.

An off-plan investments means that you will be committing to pay the balance in the future and therefore could be able to access cheaper mortgage rates when the interest rates have fallen as anticipated by the market. Compare this to buying a completed property where you will be forced to accept a higher mortgage rate now, even with the knowledge that you will be paying over the odds in future.

Another strategy to take advantage of the current and predicted mortgage rate situation is to buy cheaper properties in cash. By doing so, you can avoid high mortgage rates now and save money immediately when compared to investors who borrow to fund their purchase.

Furthermore, it will also give you the opportunity to benefit a second time when the market returns to normal as predicted in the coming years. If you manage to buy more affordable properties in high growth potential areas, you can then remortgage them when rates have dropped from the end of 2023 onwards. Taking either of these approaches to investing offers you the best of both worlds and a potential path to earning more while spending less in 2023 and for years after that.

Want to learn more about off-plan property and how it can help you get the most for your money? Get in touch with our team today by clicking here.

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