UK mortgages: rate rises are hitting home

The recent house price boom was built on ultra-cheap money. Higher interest rates pose a threat to its foundations. But stricter lending regulations and a tighter labour market should limit the damage compared with past downturns.

In the financial crisis, the average UK house price fell 17.5 per cent in the 17 months to May 2009. That was not as bad as the early 1990s when values fell 20 per cent in cash terms.

Tighter regulations imposed since the financial crisis should make borrowers less exposed than in the past. Households’ average debt-to-income ratio was 131 per cent this year, compared with its 2008 high of 152 per cent.

But affordability restrictions will reduce buying power and thereby house prices. At the start of this year, mortgage lenders could offer a loan-to-income ratio of as much as five times. If the bank rate rises to 5.9 per cent next summer, that affordability ratio would drop to 3.7 times.

That would reduce the maximum mortgage raised by a first-time buyer earning £55,000 by a quarter to £203,000, according to Capital Economics. It has pencilled in declines of 10-15 per cent, based on a reversion to long run loan-to-income ratios, tempered by rising incomes and declines to base rates once the economy cools.

Share prices in large UK banks, despite common equity tier one capital ratios in the high teens on average, have sold off in recent weeks. That reveals the market’s concern about both future mortgage volumes and expectations of higher credit costs (provisions) to come.

The growing cracks in the housing market also prompted investors to sell down housebuilders. Shares in Barratt Developments, Taylor Wimpey and Persimmon dropped by about 5 per cent on Thursday. The sector trades on a 25 per cent discount to net asset value.

Some perspective is needed. A 15 per cent fall would take the average UK house price back to £243,000, about 5 per cent higher than it was in January 2020. More conservative mortgage lending reduces the risk of negative equity. In 1992 that affected more than a fifth of those who had bought property in the previous four years.

Repossessions hit a record high of 75,000 in 1991. But that was fuelled by 9 per cent unemployment. Without a drastic weakening of labour market, very high levels of repossessions should remain a bad memory of the past.

The Lex team is interested in hearing more from readers. Please tell us what worries you have about the UK house market, if any, in the comments section below.