Will UK house prices collapse due to cost of living and inflation?

As the pandemic’s turmoil subsided, a new era of economic turmoil replaced it.

The consumer price index inflation rate in July was 10.1 percent, a level not seen in the country since the 1980s. In response to mounting costs, the Bank of England raised its base rate to 1.75 percent on August 4 – the biggest rise in 27 years.

And the worst may be yet to come, as investment bank Citi expected inflation to reach 18.6 percent in January.

Not only has high inflation strained household budgets by making necessities like food and fuel more expensive, but it has also pushed up mortgage rates – leading some to predict that UK house prices could start to fall.

The typical two-year fixed rate mortgage has risen to more than 4 percent for the first time in nearly a decade, according to Moneyfacts.

An average of 4.09 per cent means monthly mortgage payments of £200,000 are about 18.6 per cent more expensive than the same period last year, when the average was 2.52 per cent.

It comes amid a cost-of-living crisis which could see household energy costs rise to more than £5,000 by the spring of next year.

For many, life is becoming increasingly unbearable. If beer were rising at the same rate as energy prices, a pint would now cost £25.

But for now, housing prices continue to rise. In the year to July house prices rose by 11 per cent, according to Nationwide, bringing the average property price in the UK to £271,209.

It was the 12th consecutive month that house prices have increased, and real estate portal Zoopla expects them to rise 5 percent in total over the course of 2022.

The average property now costs nearly nine times the usual salary, with the affordability of house prices in England reaching the worst level ever recorded by the Office for National Statistics.

This is Money takes a look at what might happen to home prices over the next year.

The price of the house depends on the mortgage rates

The UK housing market has boomed during the pandemic, with many people using lockdown as an opportunity to save money and re-evaluate their priorities in terms of where they want to live.

The momentum has been kept up by the government’s stamp duty holiday, when buyers can save up to £15,000 in tax on their home purchase.

Home prices have continued to grow, although there are some signs of slowing momentum.

In its latest data, the Nationwide Building Society noted “tentative signs of slowing activity” in the housing market, as the number of mortgages approved for home purchases fell in June.

This has not yet translated into a drop in house prices, Nationwide said – but many experts believe it is only a matter of time.

In its latest home price index, Zoopla said it expects the number of buyers seeking a new home to decline at the end of this year, as budgets have been hit by rising costs of living and rising mortgage rates.

Richard Donnell, CEO, told This is Money that the direction home prices take over the next 12 months will depend on how much mortgage interest rates increase.

“We expect the pandemic to continue to spur home demand into 2023 and beyond as a result of working from home and retirees,” he said.

The cost of living may force some families to relocate in order to save on operating costs, especially those with lower incomes.

“However, the outlook for housing demand really hinges on how high mortgage rates are and the economic outlook.”

Commenting on current mortgage rates, Donnell says 4 percent — about the current two-year fix average — is a key level, and if rates continue to rise, we can expect home price growth to drop to zero.

“If prices increase further, modest declines in house prices would be a likely outcome as demand shrinks and we see more of the buyer’s market,” he says.

Prices may fall by 5% next year

Ray Bolger, chief technical director of mortgages at broker John Charcoll, expects mortgage rates to rise above 4 per cent as the Bank of England looks likely to continue to raise the base rate.

Fixed-rate mortgages do not automatically track a rise in the principal rate, but lenders will usually increase rates for new applicants somewhat in the following days or weeks.

Looking at benchmark variable rates, to take one example, Barclays is sitting at 5.24 percent after the latest 0.50 percent increase.

If the prime rate rises to 3 percent, that will likely be directly reflected in the standard variable rate mortgage. A £150,000 mortgage at 5.24 per cent over 25 years would cost £897.99 per month. At 6.49 per cent, the price rises to £1,011.87 – an extra £112.88 per month.

Looking at flat rates, the person with the cheapest five-year mortgage on the market in 2017 could have had a rate of 1.69 percent, according to mortgage broker, L&C Mortgages.

As of today, the cheapest five-year fixed rate deal is 3.63 percent.

This means that someone who pays off a £200,000 mortgage over 25 years can expect to pay £914 a month instead of £818 or £96.

Only this week Accord Mortgage raised its rates by 0.4 to 0.5 per cent for remortgage, while Halifax bumped its rates by 0.3 per cent.

Bolger says that if the base rate rises to 7 percent, it could see home prices drop by as much as 25 percent because mortgages have become so expensive. But he didn’t think they would go that far.

“In 2022, I think we’ll see an overall increase of 3 percent, which reflects the uptick we’ve seen over the course of the year and the slower growth in the next few months,” he says.

“And then next year I would expect a drop of about 5 percent if interest rates continue to rise.”

According to the ONS, the average house in the UK now costs £305,000, and a 5 per cent depreciation would bring the price to £289,750.

Many believe that lower prices will not go much further. In its latest market report, Zoopla said “significant” declines in home prices are not expected.

Good news for first time buyers?

Stagnant or declining home prices can be disappointing news for homeowners who are used to seeing their equity rise in value. However for first time buyers this could be an opportunity to get onto the housing ladder.

The interest rate gap between small deposits and large mortgages has narrowed significantly since inflation started to rise. The cheapest mortgage for someone with a 10 percent deposit is currently just over 0.25 percent with a 40 percent deposit.

“For first-time buyers and smaller deposits, this eases some of the pain of rising interest rates,” Bailey says.

In addition, the Bank of England recently removed the requirement for banks and building societies to conduct an affordability test to prove that buyers could afford a 3 per cent rise in interest rates.

This means that lenders have more flexibility when offering mortgages to first-time buyers, although it is expected that many will continue to hold their stress tests to similar levels.

Some say that home prices will continue to grow

Although many experts predict a slight decline in home prices next year, there is no absolute consensus.

Jeremy Leaf, a north London estate agent and former president of the Royal Institution of Chartered Surveyors, says he has not yet seen signs of slowing down.

He argues that when there has been a significant decline in home prices in the past, it was usually preceded by an increase in the number of homes repossessed because the owner could not afford the mortgage. Leif says he hasn’t seen any evidence of such an increase yet.

The UK also currently has a high employment rate estimated at around 75.5 percent according to the Office for National Statistics.

This marks another difference from the last time home prices fell dramatically in the 2007-08 recession, when employment hovered around 70 to 71 percent and many felt less secure in their jobs.

The rise or fall of house prices is also felt differently in different regions within the UK.

According to the latest data from Zoopla, Wales saw a price increase of 11.1 per cent in June, compared to just 4 per cent in house prices in London. Demand remains strong in more affordable markets and towns outside the South East of England.

Home shortages may support home prices

While demand for real estate may be slowing, there are still far more buyers than homes for sale.

The number of properties being sold is still high compared to previous years.

Data from HMRC shows that the number of residential property transactions in the UK increased by nearly a third year-on-year in July, as buyers tried to ride out rising mortgage rates.

“The supply of real estate is not keeping up,” says Rachel Springol, financial expert at MoneyFacts. The rise in home prices is unlikely to stabilize until this is corrected.

“We may see a seasonal slowdown in the fourth quarter of 2022, but real estate market demand can be volatile during these unusual circumstances, especially when affordable housing is not being built fast enough.”