How inflation can affect the housing market

Ned Browne 17 August 2021

Inflation is rising, and that could have a knock-on effect on the housing market—here's how

In June 2021, inflation rose to 2.5%, pushing even further above the government target of 2%. Most economists agree that inflation is likely to rise to at least 4%, but that’s where the agreement ends. Some economists think inflation will come and go as global supply chains recover post pandemic; whereas others think inflation may wreak economic havoc in the years to come.

How does inflation affect homeowners and aspiring homeowners?

Illustration of man balancing on coin

The big question is this: what’s the impact of rising inflation on interest rates? If climbing inflation does turn out to be a short-term blip, it’s likely the Bank of England will keep interest rates low, not wanting to risk destabilising an already-fragile economy. However, if the inflation rise turns out to be more pernicious, it’s likely that interest rates will rise too. This will push up the cost of borrowing, which is likely to suppress the housing market.

For aspiring homeowners, rising interest could be both a blessing and a curse. It would make property prices look more affordable, but monthly mortgage payments would be higher.

Who determines interest rates?

Bank of England

The Bank of England, source: Wikimedia Commons

Each month, the Bank of England’s Monetary Policy Committee (MPC) analyses a number of economic indicators such as economic growth, the rate of inflation and the level of unemployment and, based on these, decides the base rate. If the MPC thinks the economy is overheating, it will increase interest rates, and vice versa.

Lessons from history

It’s worth noting that, when the Bank of England lowered the base rate to a historic low of 0.5% on Thursday 5th March 2009, few would have predicted that it would still be below 1% more than a decade later. Fewer still would have predicted the impact of the COVID-19 pandemic.

On 10 March 2020 the MPC slashed the base rate to 0.25%. Ten days later the MPC dropped the base rate again to 0.1%. Bear in mind that interest rates have never before been below 1% since the Bank of England was founded in 1694.

Act to protect yourself

Interest rates have remained low for a long time, but there is no guarantee they will continue to do so. If you are concerned about the impact of future rate rises you should get your mortgage fixed for as long as possible.  

The mortgages available change on a daily basis and all borrowers should shop around for the best deal. Loyalty does not pay when it comes to mortgages. In fact, it rarely pays with any financial product.

Even if you have a repayment mortgage, you should also consider making additional over-payments every month. Almost all mortgages allow this, and you should not underestimate the value of compound interest. Here’s a hypothetical example: if you overpaid £1,000 a month on a mortgage that charged 4% interest you would pay £144,000 less in interest payments over a 25-year period.

Are there any benefits of rising inflation?

Definitely yes if you are a saver. But, oddly, there are benefits as a borrower too: inflation erodes the value of money, meaning mortgage debt reduces in real terms in line with inflation.

The known knowns

It’s impossible to predict with any certainty what will happen with inflation and interest rates. Yet we do know this: currently the base rate is just 0.1%, meaning it’s unlikely to get any lower.  

So, as mentioned above, take advantage of this and secure a fixed rate mortgage. After all, being able to afford your monthly payments is what counts.

Read more: Are influencer's giving bad investing advice?

Read more: The dark heart of the Pickup Industry

Keep up with the top stories from Reader's Digest by subscribing to our weekly newsletter