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Economics 101: The Relationship Between the Mortgage Market and the Economy

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By Nitesh Patel, Strategic Economist at Accord Mortgages 

No-one needs me to point out how much change we’re seeing in the mortgage market these days, much of it at pace, but understanding how these changes impact the economy may be of interest, or indeed of use when speaking to clients.

Let’s take the Bank base rate as a first example, which is seemingly climbing at most Monetary Policy Committee (MPC) meetings. For many borrowers – and perhaps even some newer brokers – it’ll be the first time they’ve experienced a rising rate environment and for some, the increased outgoings for variable rate mortgages, or those on a lender’s standard variable rate (SVR) may be alarming. But what is the relationship between the economy and the mortgage market?

I touched on this previously, but inflation stands at 10.1% in July 2022, compared to 2% in July 2021. The Bank of England’s role is to ensure a stable inflation rate around a 2% target, and its main tool to bring inflation under control is to raise the Bank Rate, which increases the cost of borrowing – for both households and businesses.

Since December 2021, the Bank Rate has gone up from 0.10% to 1.75%, having been 0.5% for the best part of the decade since April 2009. The ‘effective’ interest rate – the actual interest rate paid – on newly drawn mortgages has increased by 57 bps since last December, whilst the quoted rate on a two-year 75% LTV loan has already risen from 1.6% at the start of 2022 to 2.9% in June. This will quite clearly have an affordability impact on new home buyers – and so we could see a slowdown in new business. Since January, mortgage volumes for house purchases have been easing. This is partly explained by a natural slowdown in activity which had been in overdrive for two years. But higher house prices and rising mortgage rates will have played a part.

With energy prices rocketing, the long-awaited tax increases now in place and recurring Bank rate rises, households are feeling the squeeze as the cost of living crisis bites.

Removal of stress tests

Another recent change brought about by the Bank is the removal of affordability tests for borrowers. This prompted much speculation about the impact it would have on aspiring homeowners and movers’ ability to purchase property, but in reality I’m not sure we’ll see any significant changes.

Responsible lenders will continue to assess borrowers’ affordability to make sure they do not lend more than someone can afford to repay, and the loan-to-income limits – the main influencing factor for affordability – haven't changed.

This change – though widely talked about – has happened in a very different environment to the one we saw immediately following the financial crash. Lenders still fully assess mortgages on current and future affordability, but not at what you could class as unrealistically high stress test levels. Many forecasts don’t suggest the base rate will rise more than 3%, so removing much higher stress tests should really only help borrowers, and will contribute to stimulating the market, not constricting it.

Record-low mortgage rates are no more

Finally, the significant rise in mortgage rates – in part linked to Bank base rate rises – cannot go unnoticed.

Whether it’s the ring-fenced banks, access to cheap Government funding, or increased customer savings from the pandemic years, there’s been a lot of liquidity in the market recently and many lenders have been holding far more cash than normal. In the last 18 months, and with – until recently - a historically low base rate, many lenders have been able to pull a price lever to increase competition in the mortgage market, which contributed to the record-low mortgage rates we saw.

But the tide has turned, and as we weather the storm brought about by rising mortgage rates, it’s worth understanding that there’s more to funding mortgages than meets the eye – if nothing else to bust any misunderstanding that today’s increased rates are solely the result of decisions on Threadneedle Street.

Lenders use diverse funding methods to provide greater stability, consistency and flexibility, usually through a combination of wholesale markets, government funding schemes and in our case, as a building society, a simple business model that uses members’ savings to enable mortgage customers to buy a home.

What economic impacts do I think we’ll see as a result of these rate rises? Well, mortgage payments as a proportion of take-home pay could surge, and with inflation outpacing wages, it’s reasonable to expect demand for housing to slow, and house price inflation to stall too in the long term – although in the short term, we’re continuing to see supply shortages of housing stock which exacerbates the rising house prices we’ve seen to date.

But I’ve been in this game long enough to know our housing market is very resilient. Even recently, demand was spurred by the effects of the pandemic, barely faltered with the removal of the stamp duty deadline and saw monthly mortgage approvals average at 68,000 since last October (2021), compared with 65,700 in 2019.

Any impact of recent changes in the economy won’t be felt in the mortgage market overnight, but it will definitely be worth keeping an eye on. After all, having a more rounded view of the housing and mortgage market, in the context of the wider economy, will likely only add value to client conversations.

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