House prices & mortgages: Why do house prices fall when mortgage rates rise?

Following years of house price inflation, there's a feeling in the air the property market is on the brink of turning. Already this year we've seen house prices slide, and many are predicting further falls over the coming months.

Whether you're a homeowner or first-time buyer, you may be wondering whether mortgage rates are likely to continue rising. And if so, how is this likely to impact house prices going forward? Let's take a look...

What is happening to house prices right now?

According to Nationwide's most recent House Price Index, the average property price in June 2023 was £262,239 — 3.5% lower than in June 2022.

Meanwhile, Halifax's rival House Price Index paints a similar picture. It suggests house prices have fallen 2.6% over the same period, and that the average house now costs £285,932.

While there are clear discrepancies between these two major indexes, the conclusion is clear: UK property prices have fallen by a decent margin over the past 12 months or so.

Whether we’re past peak falls remains to be seen of course. Nationwide will release its figures for July a few days either side of the end of the current month while Halifax will update its index on Monday 7 August. Once we have the data for July, we’ll have a clearer idea as to whether we can expect house prices to continue falling in the second half of the year.

On this note, we should say that there are winners and losers when it comes to falling house prices. While landlords with multiple properties may wince at the thought of falling prices, first-time buyers, or even existing homeowners looking to ‘trade up’ their home typically ‘win’ when prices fall. That’s because, by definition, lower house prices make them cheaper to buy. And if you already own a property and are looking to buy a more expensive home, while your existing home may have fallen in value, it’s likely that the more expensive property you're looking to buy will have fallen by a bigger margin.

What is happening to mortgage rates?

On Wednesday 19 July, the Office for National Statistics revealed UK inflation had fallen to 7.9% in the 12 months up to June 2023, the lowest it's been for a year.

Following the announcement, average mortgage rates dipped slightly amid expectations the Bank of England will be less likely to continue hiking interest rates.

Yet despite this dose of good news, mortgage rates remain much, much higher than a year ago. At the time of writing on Friday 21 July, data analyst firm Moneyfacts reports the average two-year homeowner mortgage rate is now 6.8%, while the average five-year fix is 6.32%. For comparison, back in October 2021 the average five-year fixed rate mortgage was just 2.55% which shows the extent of rising mortgage rates over the space of the past 20 months.

According to UK Finance, almost 2.5 million fixed-rate mortgage deals are set to expire between now and the end of 2024. This means vast numbers of remortgaging homeowners will soon face higher monthly payments.

Are mortgage rates likely to continue rising?

It’s fair to say that higher mortgage rates are likely here to stay. The era of ultra-low interest rates is now over, and borrowing costs have essentially reverted to levels that, historically, aren’t anything out of the ordinary.

The question of whether mortgage rates will continue rising will depend on whether the Bank of England can get to grips with inflation. For a large chunk of the year the UK has suffered from double-digit inflation, which is why the UK’s central bank has hiked interest rates on four separate occasions so far this year.

And while the Bank’s Monetary Policy Committee is likely to hike rates yet again when it next meets on 3 August, following the ONS's recent data which reports inflation has fallen by ‘more than expected’, many analysts are now suggesting the Bank of England's next hike could be just 25 basis points, rather than the 50 basis points rise many had previously predicted.

If this does turn out to be the case, and subsequent ONS statistics reveal inflation continues to fall, then mortgage rates could soon began to level out. Of course, mortgage rates may have already peaked, though it’s far too early to tell.

What is the relationship between house prices and mortgage rates?

We know that when interest rates rise, mortgage rates also typically edge upwards. But what about the relationship between mortgage rates and house prices?

Usually, when mortgage rates rise, house prices fall, and we’ve already seen some evidence of this happening over the past few months.

The reason why mortgage rates typically have an inverse relationship with house prices is because when mortgage rates are low, budding homeowners are able to borrow more cheaply, and can therefore take on more debt.

This is why when rates are low, home buyers might be inclined to borrow as much as they possibly can in order to finance the biggest and best house they can afford to buy.

In other words during times of low interest rates, taking on a big, fixed mortgage — where the vast majority of your monthly payments is spent on capital repayments — is a low-risk move for many buyers.

In contrast, when mortgage rates are high, sensible home buyers have to be a lot more careful about the amount of debt they take on. For example, when average fixed mortgage rates go above 5% or so — as if the case today — buyers must seriously consider the impact of interest payments on their mortgage. That’s because it's likely a large proportion of their monthly payment will go towards servicing mortgage interest.

This is why, when mortgage rates are high, buyers are usually less eager to take on big mortgages.

And even if there are still lots of buyers who are willing to pay high interest, banks are often less willing to lend to those with low deposits in a high interest environment, especially first-time buyers, due to the increased risk of these buyers falling into negative equity.

These are two big reasons why higher mortgage rates can have a huge impact on the amount buyers are able and/or willing to borrow. And this is also why higher mortgage rates usually leads to a fall in house prices.

Why haven’t house prices fallen by a bigger margin in 2023?

Now we’ve explained why there’s usually downward pressure on house prices when mortgage rates rise, you may be wondering why house prices haven’t fallen by more than 3.5% over the past 12 months — especially when we consider buyers now have much higher mortgage rates to contend with.

While we’ve explained why house prices typically fall when mortgage rates rise, it’s extremely tough to predict the exact trajectory of the property market. For example, while average house prices are cheaper than a year ago, it’s impossible to say if falls have peaked, prices will continue sliding by a percent or two, or whether we’re at the cusp of a serious crash.

The reason for this is that house prices aren’t solely determined by mortgage rates. Sure, credit availability is a big factor that can impact prices, but other factors such as lack of supply, strong demand, stringent planning laws, forbearance of lenders, and the UK’s growing population are other important variables that can impact house prices. And a combined mix of these external variables is likely to be the reason why the market hasn't experienced a significant crash (so far at least).

So, in summary, when it comes to the relationship between mortgage rates and house prices, here are the key points you need to know:

To learn more about the property market, take a look at our article that explores house prices in regions across the UK