How Does Inflation Affect Mortgages?


Inflation is a hot topic at the moment and seems to be in the news every day. You may be wondering what effect this will have on mortgages and what, if anything, you can do about it.

What is inflation and what causes it?

In simple terms, inflation is a measure of the rising cost of goods and services. The rate of inflation is shown as a percentage figure and is calculated as the difference in cost of a number of items now, versus a year ago. 

Inflation can be caused by many different things and when kept at a low level, is actually a good thing for the economy as it shows that the economy is growing. 

However, when the rate of inflation is too high, it causes problems with the economy as the money in your pocket doesn’t go as far as it once did and people start to feel poorer. 

Inflation is often caused by events around the world that impact the availability of goods, such as a war. At the time of writing, the situation in Ukraine is having a massive impact on energy prices, which then causes the cost of almost everything to increase. This is driving inflation up to a high level at the moment. 

Is inflation good for house prices?

Inflation can initially push house prices up, which can be seen as a good thing for homeowners. However, high inflation will, over time, reduce the ability for first time buyers to save a deposit for their first home, meaning they will be unable to buy. 

This could then mean that there is a surplus of properties on the market, especially at the lower priced end of the market, which will result in prices reducing.

Why does inflation impact mortgages?

One of the Bank of England’s main roles, given to them by the government, is to keep inflation under control (they currently have an inflation target of 2%). When the rate of inflation starts to rise above this level, one of the main tools the Bank of England can use to try and bring it back down is to raise the Base Rate of Interest. 

This is the rate that is announced on the first Thursday of every month and is commonly on the news that day. By increasing interest rates, they are aiming to deter people from borrowing money and also to encourage savings. 

This will, in turn, result in a lower demand for goods and that will drive prices down, therefore reducing the rate of inflation.

How does a rise in inflation affect mortgage rates?

When the Bank of England increases the Base Rate of Interest to try and slow the rate of inflation, this will ultimately lead to higher mortgage rates. 

Although the only type of mortgages that are directly linked to the Bank of England rate are Base Rate Tracker Mortgages, the reality is that mortgage lenders variable rates will increase as the cost of raising money for the banks increases.

If you are part way through a fixed rate period in your mortgage, then any interest rate change won’t immediately impact your mortgage. Although new fixed rate mortgage deals offered are not directly linked to the Base Rate, in reality, they will increase as well. This will mean that when you are applying for a new fixed rate mortgage, either to buy a new property or remortgage when your current fixed rate expires, you will find that rates could be higher than they were previously. 

Does inflation favour lenders or borrowers?

Inflation certainly does not favour borrowers; as prices increase, disposable income will reduce. 

It can help lenders in some way, as rising interest rates could improve their profit margins initially. However, if there are fewer people looking to borrow over time, then lenders may have to reduce their rates to remain competitive as there will be fewer applications in the market. 

Overall, a high rate of inflation is probably not a good thing for either party over the longer term

FAQs about inflation and mortgages

Will inflation affect fixed-rate mortgages?

Existing fixed rate mortgages won’t be affected by inflation.

New fixed rate mortgages being offered by lenders will become more expensive if interest rates rise to try and control inflation.

What happens to variable rate mortgages during inflation?

There are two main types of variable rate mortgages on the market. The most common is a Tracker rate, which will usually track the Bank of England Base Rate. So when the base rate rises, the mortgage rate will rise by exactly the same percentage.

The other type is one that is linked to the lender’s own Standard Variable Rate. Although these are not directly linked to the base rate, they are likely to also increase when the base rate increases, but that may be by a higher or lower percentage rate than the base rate increase.

When is the right time to buy a house in reference to inflation?

This is an impossible question to answer, as the right time to buy a house is usually when you need to. Unless you are buying as an investment property, you should make the decision based on your personal circumstances. 

Of course, you should take everything into consideration, but as long as you take the correct advice and know how the financial climate will affect you, then the right time to buy is “when you need to.”

Should I be worried about my mortgage during periods of inflation?

We would never say you should be worried about your mortgage. It is important that you fully understand how the wider economy will impact you personally and your mortgage is a large part of that. 

We would always recommend speaking to a qualified advisor, such as ourselves, who will be able to explain your options and guide you as to the best course of action for your personal circumstances.

About the author 

Gary Oxborough

Gary is the Founder and Director of Barlow Irvin Financial Services Ltd. He has been in the Finance industry for over 20 years and has specialised in Mortgages since 2003. As well as running the firm, he is still actively involved in advising clients.

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