How can the Bank of England affect house prices?

How can the Bank of England affect house prices?

August 9, 2016

How can the Bank of England affect house prices?

When you’re applying for a mortgage, the first thing you’ll undoubtedly check is the interest rates available: how much the loan itself will cost you to take out. Usually, your mortgage will rise and fall in line with national interest rates, possibly with a period of fixed interest, either as part of a “variable-rate” mortgage or a “tracker” mortgage. The national interest rate is set by the Bank of England, and is known as their “base rate”, the rate at which they lend to other financial institutions.

The level at which the Bank of England sets this rate has an impact on the cost of your mortgage, the ease with which you can be approved for a mortgage, and the amount of money you’ll be able to borrow. Understanding why the Bank of England varies their base rate and what impact it has on you is important when taking out a mortgage:

Why does the Bank of England vary the base rate?

The Bank of England’s job, along with the Financial Policy Committee, is to safeguard England’s economy and ensure that it remains stable, productive and resilient. This is partly ensured by the existence of the Prudential Regulation Authority and the Financial Conduct Authority, two subsidiaries of the Bank who are responsible for overseeing and regulating the financial markets, but the Bank itself has a great deal of influence over the economy through adjustments to the national rate of interest.

The Bank of England base rate is the rate at which the Bank lends to commercial banks, and is used by these banks to calculate the rate at which they should lend money. Because the base rate effectively influences how expensive or cheap it is to take out a loan, changes to the base rate have an impact on the behaviour of lenders and borrowers all across the country.

What effect does a higher base rate have on borrowers?

By increasing the base rate, the Bank makes it more expensive for borrowers to take out a loan: it becomes more economical to invest money in a current or savings account, as the increased interest rates available offer a greater return.

Buyers with large mortgages are hit disproportionately hard by rising interest rates, as the interest on their loan will cause their monthly payments to rise substantially: most mortgages are structured so that the first few years of payments constitute interest payments only, so a rise in interest rates during the first years of a mortgage often means a large increase in payments for home owners. For this reason, mortgages with an initial fixed-rate period can provide valuable protection while you’re making your first few years of payments.

Raising the base rate tends to have a slowing effect on the economy, so the Bank usually keeps interest rates low during periods of economic sluggishness. During an economic boom, though, raising the interest rate can incentivise lenders to make more money available to borrowers. It’s also an effective way to curb over-inflation, as consumers will have less money to spend.

What effect does a lower base rate have on borrowers?

By reducing interest rates, the Bank is able to incentivise borrowing: cheap loans are available, making it possible for companies to expand and for individuals to purchase new properties. In periods of economic recession rates are kept low to stimulate the economy, incentivising spending and lending: low interest rates encourage consumers to invest, by reducing the amount of interest available from savings products.

How does the base rate affect my mortgage?

Depending on the type of mortgage you have, fluctuations in the base rate may have a greater or lesser impact on your interest payments. Most mortgages are variable-rate, which means that your mortgage provider can increase or reduce their rates during the term of the loan, usually in response to the base rate (though not exclusively). This means that if base rates rise, your mortgage will likely become more expensive, though a 2% increase in the base rate might not necessarily cause a corresponding increase in your interest rate: if your provider wishes to keep their products affordable, they may choose to raise rates by a smaller amount, or may decide they can get away with a greater increase. If your mortgage is set to track the base rate (a “tracker” mortgage”), it will mirror any variations exactly; a 2% rise in base rate will cause a 2% rise in your interest rate

Fixed-rate mortgages avoid expensive fluctuations in the base rate by remaining fixed at a constant rate, but these are typically more expensive to begin with. Capped rates are also available, which limit your interest rate to a certain ceiling – this ceiling might be quite high, however, so be sure that you can afford raises up to this level!