Will London house prices crash amid rising interest rates and mortgage repayments?

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House prices in London are expected to fall by 10 per cent in the next two years after the Chancellor’s mini-budget tanked the mortgage market.

Higher Interest rates and mortgage payments, tighter lending and a cost-of-living crisis could spell “a year of pain” for first-time homebuyers and existing mortgage holders as sales plummet and prices slide.

Forecasts released today by estate agent Knight Frank predict a median house price drop in the capital of 10% in two years, bringing values ​​back to where they were at the start of 2021.

Property analysts called Kwasi Kwarteng’s emergency fiscal package “inflationary” and “reckless” and even 12 days later, the industry is still struggling to predict how much interest rates will rise. Those mortgage products that were pulled from shelves last week are still being revalued, adding to the chaos.

Knight Frank’s head of residential research, Tom Bill, told Homes & Property that the UK was in a state of disorientation. “During the summer we were already expecting a rise in interest rates to deal with global inflation caused by rising fuel costs and the war in Ukraine. Currently, it looks like the mini-budget will push interest rates even higher. But we will reassess as the picture clears up,” he says.

‘A year of pain’

For first-time buyers, high loan-to-value mortgages will be less available and more expensive to maintain, making the dream of homeownership more elusive. As interest rates rise, so will mortgage payments, preventing second and third steps from growing into a larger single family home. “Those with variable rates will feel the pain right away,” says Lucian Cook, head of residential research at Savills. “We’ll see the house price growth of the last two years unravel,” he adds. Savills’ most recent house price outlook in June forecast a one per cent drop in prices in London in 2023 in response to expected incremental interest increases.

But 1 percent is no longer a “reflection” of the market, says Cook. She is waiting for official interest rate estimates from the Office of Budget Responsibility to make her next set of predictions in November.

The Bank of England’s base rate forecasts (which dictate interest rates) rose as much as 6 percent last week from the current 2.25 percent. Martin Beck, chief economist at the EY Item Club, dismisses such speculation as hysteria. “However, they will certainly land at a higher rate than anticipated just two weeks ago. It will be a year of pain,” he says.

As a result, Cook hopes that anyone who doesn’t need to act now will stop for the foreseeable future. “They will reconsider what they can afford and pull out of the market for now,” Cook explains. “They will wait for the market to stabilize and interest rates to peak and come down, which could take 12 to 24 months.”

This will be most acute in London, where house prices are higher and people have worked harder to borrow. Those with adjustable-rate mortgages will see payments increase immediately, and homeowners nearing mortgage renewal are now trying to renegotiate as lenders reprice products.

What about first time buyers?

Cook expects more potential first-time homebuyers to be stuck in expensive rentals without being able to afford a mortgage. “We can see Mom and Dad’s bench sitting on their hands, feeling the pinch too,” he says. “In fact, they may have to help their children make mortgage payments.”

The number of mortgage searches by first-time buyers had already started to drop, according to data from mortgage technology company Twenty7Tec, dropping from 10,305 in August to 9,765 in September on its platform that amalgamates mortgage products. The amount they borrowed also fell, from 74 percent loan-to-value to 72 percent, pushing the deposit requirement even higher.

This occurs against a backdrop of rising costs of living and rising rents, leaving prospective buyers with less disposable income for a deposit.

Two factors are working in the first-time buyer’s favor after the mini-Budget: lower property prices and the latest stamp duty cut, explains Lindsay Judge, chief policy officer at the Resolution Foundation.

The tax grant in the mini-budget included a full cut in stamp duty on homes worth less than £425,000, setting it at 10 per cent on homes between £425,001 and £625,000.

Before former Chancellor George Osborne’s stamp duty review in 2014, a first-time buyer paid £12,000 in stamp duty on a house costing £400,000 and £10,000 before this latest round of cuts. Following the mini budget, a first time buyer will pay £3,750.

On the other hand, mortgages will be more expensive to pay. “If home prices drop, they’ll be in a better position, but they’ll need more income to pay the mortgage,” says Judge. “It’s giving with one hand and taking with the other,” he adds.

Both mortgage and deposit payments are now barriers to entry for first-time buyers facing rising rents and living costs.

Is London headed for a downfall?

Regional (cities outside of London) and rural (small towns and villages) markets saw an unexpected rise in sales and prices after the first lockdown as people cashed in on city property and sought more space.

The London market has been more subdued, both during the extended period of Brexit uncertainty (from the referendum in 2016 to the withdrawal in 2020) and during the Covid crisis with the absence of foreign buyers and movement out of the capital.

Chart: London house prices since 2006

House prices in London

/ Knight Frank and nationally

In fact, house prices grew by more than 20 per cent from March 2020 to July 2022 (Land Registry) in England and Wales, almost double that of London.

“This is a much more resilient market than it was in 2009, when high loan-to-value mortgages were fully retired. This time they have been temporarily withdrawn to change the price and have undergone strict loan management and stress testing prior to release,” says Andy Shepherd, CEO of Dexters.

Household savings are healthier than anticipated as people saved during the pandemic and the UK has not yet entered a recession, Judge explains. “Recent data from the ONS shows that the economy had grown 0.1 percent in the second quarter, but even if we don’t have a formal recession, there will be some sort of retraction,” she warns. The lack of housing supply to satisfy demand will also continue to cushion price falls.

James Mannix, head of developments at Knight Frank, expects the pound’s weakness to attract more foreign buyers and investors to the new-build apartment market, again reducing opportunities for first-time buyers. Meanwhile, in London’s luxury core, property prices are now 5.3% higher than pre-Covid, though still well below the 2014 peak. In Knightsbridge, for example, prices are 24% lower, while the weak pound offers a buyer buying in US dollars a full 53% discount, according to research by Knight Frank.

Light at the end of the tunnel

Following the Prime Minister’s U-turn to lower the top tax rate, money markets and wild interest rate predictions have started to stabilize. This will also be aided by Kwarteng’s promise that official and independent (OBR) forecasts will be coming “shortly”.

Although Beck speaks of “a year of pain,” he can see a light at the end of the tunnel for mortgage holders and first-time buyers. “All the forces that fuel inflation are slowing down. As a result, inflation should start to reverse towards the end of next year, at which point interest rates may drop rapidly.”

All of this distracts from the chronic housing shortage in London that exacerbates the affordability crisis. Mannix calls on Truss and Kwarteng to “make housing supply a priority and urgently deliver affordable housing for Londoners.”

key events

The 2008 accident

Mortgage lending had gotten out of control. Very high loan-to-value loans went unchecked, so when prices fell, many homeowners found themselves with negative equity and were forced to sell at a discounted price.

This pushed down the average price, as did the drop in transactions.

The recovery (2008-2014)

It was unexpected and fierce. Some buyers who bought their first flat in 2008 earned more than £100,000 in just a few years as prices rose steeply to peak in 2014. Annual house price growth in the capital was more than 20 percent.

Mortgage Market Review (2013)

Changes introduced through the Bank of England meant that lenders had to stress test borrowers and see if they could afford repayments if interest rates (which were set at record lows) rose.

Stamp duty reform (2014)

A revision of the stamp duty increased the tax on larger houses. This cooled down an overheated market.

brexit

Sentiment dimmed, especially in central London and the new-build market, which relies heavily on wealth abroad. With fears of a Labor government and a possible mansion tax, demand from overseas buyers has dwindled.

Early 2020 and the impact of Covid-19

A long-awaited recovery for the capital seemed likely after Boris Johnson’s landslide election victory.

The effects of the pandemic hit London as buyers cashed in and shopped further afield for more space.

And now?

London house prices should be cushioned against a 2008-style crash.

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