How does inflation affect mortgage rates? Our experts explain

You’ve no doubt seen how inflation affects your everyday purchases, but how does inflation affect mortgage rates?

Inflation is running at a 40-year high, creating a cost of living crisis that is squeezing household finances. Prices jumped 9% in the 12 months to April, according to the Office for National Statistics. And experts believe inflation could go even higher. The Bank of England warns that inflation could peak at over 10% later this year, spurred on by another hike in the energy price cap in October.

We explain how rising inflation impacts mortgages, what worried mortgage holders can do now – and whether inflation could cause house prices to fall.

What does a rise in inflation mean for mortgage rates?

When inflation rises, it can have a significant impact on mortgage rates. This is because the Bank of England looks at factors like inflation when deciding whether to raise or cut interest rates.

If inflation is increasing quickly, the Bank of England may try and tackle this by raising interest rates, which should – in theory – put the brakes on inflation.

Image credit: Future Plc/Simon Whitmore

The UK inflation target is 2%, so anything above this increases the chances of the Bank of England hiking interest rates.

The opposite is true if inflation is very low. In that case, interest rates may be cut to try and get people spending (to raise inflation) rather than keeping their money in savings.

Faced with soaring inflation, the Bank of England has responded by raising interest rates this year. In February, it increased rates from 0.25% to 0.5%. A month later, it raised them to 0.75%. In May, rates hit 1%, the highest level for 13 years.

A rise in interest rates affects mortgage rates. Some homeowners could see an increase in their monthly repayments, while first-time buyers will see mortgage rates get higher.

Mortgage rates have been rising steadily in recent months. The average two-year fixed rate is now above 3% for the first time in more than seven years, according to the analyst Moneyfacts.

Is high inflation good for mortgage holders?

Unfortunately, high inflation is rarely a good thing for mortgage holders. If interest rates subsequently rise, this pushes up mortgage rates too.

However, whether you see an instant rise to your mortgage payments depends on the type of mortgage you have.

Those on fixed-rate mortgages will be shielded from any interest rate hike. Homeowners on tracker mortgages or standard variable rates (SVRs) usually see an increase to their interest rate, and therefore their monthly payment would go up.

If you’re on a fixed-rate, you’re not completely protected from high inflation, because once it finishes, interest rates could be higher, meaning you won’t be able to get such a competitive deal.

Image credit: Future Plc/Brent Darby

What should I do about my mortgage if I’m worried about inflation?

At times of high inflation, it’s important to check all your outgoings and see if you can cut any costs to reduce the impact that soaring prices have on your finances. This includes cancelling any subscriptions you don’t use, shopping around for cheaper insurance policies, and trying to save money on your supermarket shop.

You should also look closely at your mortgage, because, after all, it’s probably your biggest monthly bill.

If you’re on an SVR – which is the most expensive type of mortgage rate – you could save hundreds, maybe thousands, of pounds a year by moving to a fixed rate. Speak to a mortgage broker if you need help searching for a new product, or if you’re unsure about your options.
The advice is to move quickly, as banks and building societies are continuously repricing their mortgages.

It’s likely interest rates will rise further this year, in an attempt to get inflation under control. ‘Some analysts expect the Bank of England rate to hit 2% by the end of this year and 3% in 2023 – pushing mortgage rates to new highs,’ says Alice Haine, personal finance analyst at the investment platform Bestinvest.

She adds: ‘Anyone with a mortgage deal set to expire soon will have to pay more each month when they renew their fixed rate, so in this era of rising rates, it is wise to shop around and lock in a new offer three to six months ahead of the expiry date.’

Image credit: Future Plc/Colin Poole

Should I pay down my mortgage during high inflation?

It’s always a good idea to overpay your mortgage – if you can afford it. During the cost of living crisis, this may not be possible as just paying your usual mortgage bill, plus other essential expenses, can feel like a stretch.

For other homeowners, you may feel you can comfortably overpay your mortgage (perhaps you have a large amount of savings, and a decent salary with good job security). Jamie Lennox, director at the broker Dimora Mortgages, comments: ‘Overpaying is always wise in my eyes.

Most mortgage interest is calculated daily so the sooner you can start chipping away at the debt levels, it’s going to save you interest in the long run. However, we appreciate not everyone is going to have the surplus money to do this with the cost of living crisis spiralling.’
If you are able to pay extra, check if there is a maximum amount you can overpay on your mortgage. If you go over this limit, the lender could charge a hefty fee.

Is inflation good for house prices?

As interest rates rise, the housing market often slows down.

However, house prices are still climbing this year, despite interest rates hitting 1%. Average house prices rose for the eleventh consecutive month in May, according to Halifax. The average UK property now costs £289,099, thanks to annual house price growth of 10.5%.

Having said that, experts believe it’s only a matter of time until the market starts to cool, and we could even see some price falls.

‘As interest rates increase, inflation worsens, and consumer confidence weakens, so it’s likely we may see house prices begin to fall. However, we must remember that they’ve shot up over the last 18 months, so for most people, it’ll be a steadying of the ship rather than crashing onto the rocks,’ notes Lewis Shaw, founder and mortgage expert at Shaw Financial Services.

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