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How are mortgages and inflation connected?

The news is full of stories about inflation, interest rates, mortgages and the cost of living. These terms are all connected in their own ways, but it can be hard to understand how they affect each other when it comes to you and your individual circumstances. In this article, we look at how mortgages and inflation are connected and what it means for you.

How does inflation affect mortgages?

Inflation is the rate of increase in prices of goods and services over a certain time period and is based on consumer spending, when increasing demand pushes up costs. The Bank of England is trying to combat inflation by hiking interest rates to make borrowing money more expensive,  encouraging the population to spend less, thereby pushing down the costs of goods. This means that if you have an existing loan, like a mortgage, you will be paying back more each month due to the increase in interest.

How will the interest rate rise affect my mortgage?

Higher interest rates affect mortgages across the board unless you have a fixed-rate mortgage. If you have a variable rate, or tracker rate mortgage, your monthly payments will go up as interest rates go up as it directly influences the amount of your house you can afford to pay for. Anyone who is coming to the end of their fixed term may want to consider securing another fixed term before interest rates increase again.It is therefore advisable for anyone coming to the end of their fixed term to try and secure another fixed term before prices increase again. 

Are mortgages included in inflation?

Inflation is measured using both the Consumer Prices Index (CPI) and the Retail Prices Index (RPI), which take into account houses costs and mortgage repayment costs. The Bank of England’s target for inflation is 2%, and the rate as of the date of this article is 6.8%. They expect it to fall by the end of 2023, with the hopes that they reach 2% by early 2025.

What does inflation mean for house prices?

When inflation rises, it can increase the price of properties but often not in line with their actual value. Essentially, if inflation is higher, homeowners are less likely to want to sell up and move, thereby reducing the number of properties available on the market. With fewer properties to choose from, those who are selling are able to push up their prices knowing that the rules of supply and demand will make the home more desirable and more likely to sell at an inflated price.

The other side of the coin is that if inflation rises too much, it will mean that new mortgages are more expensive and harder to obtain, thereby decreasing demand and causing house prices to fall. The market is unpredictable but owning a property can be a good way to hedge against inflation, although it is not always easy to see which way the cards will fall.

Will interest rates go down when inflation goes down?

Interest rates and inflation are inextricably linked, so when inflation goes down it usually follows that interest rates will go down as well. The inflation rate in July 2023 was 6.827%, compared with 7.950% for June, giving a reduction of 0.432%. Although it is coming down minutely, the effects of the interest rate increases will probably be felt for many months to come. 

It is wise for those who are feeling the brunt of mortgage repayments and a higher cost of living to consider alternative ways to reduce monthly outgoings. If you are a homeowner over 55, talk to one of our advisers about Equity Release – it could leave you better off by removing monthly payments altogether, allowing for an easier and more fruitful retirement.