Beyond the fanfare: why falling interest rates provide only partial relief
3 minutes read time
On 1 August 2024, newspapers and policymakers hailed a significant breakthrough as the Bank of England cut interest rates for the first time since the end of 2021. Finally, it appears to be time to climb down from high rates and reduce the strong medicine prescribed by the central bank to treat the most severe and persistent inflation in recent memory.
As a headline, this is good news for mortgage borrowers, many of whom have faced the prospect of or have already transitioned to higher rates. The move from historic low mortgage rates at around 2-3% to over 5% has been a tough pill to swallow, as many have seen their monthly repayments jump by hundreds of pounds. Any reduction in borrowing costs is positive; however, it is important to look beyond the fanfare to assess what lower rates mean in practice.
To do this, it is important to segment the historic significance of the rate cut from its direct impact on borrowers and their bank balances. Beyond the fanfare of the headlines, the impact of the central bank signalling a move to a lower rate environment will not be dramatic – at least in the short term. The mortgage market is highly complex with an array of borrower types, loan sizes, and personal circumstances that make the impacts of lower rates more complicated than many people realise.
Ripples in a complex market
There is no one-size-fits-all when it comes to the impact of falling rates. The UK’s housing market is built on a complex patchwork of over 10.8 million outstanding residential mortgages1. The pressures faced by these mortgage owners will vary significantly based on the length, type, and size of their mortgage, as will their exposure to changing interest rates.
We also have a large buy-to-let sector (BTL) comprising 4.6 million rented properties in the UK2, many of which are financed by mortgages. While rising rents often attract negative attention, the BTL segment is fundamental to our housing system. High rates have taken their toll on the private rented sector – reducing margins and in some cases causing an increasing number of landlords to fall into mortgage arrears. A 0.25% rate cut may be too little too late for some landlords considering cutting their losses and exiting a sector that requires steady supply.
While the near-term impact of interest rate reductions is small given it takes time for rate cuts to be felt by borrowers, the psychological impact is more considerable. The feeling that we are moving out of a difficult economic period and will soon be relieved from the burden of high borrowing costs has given the housing market a shot in the arm. Hot on the heels of a rate cut, house prices rose for the first time in two years, according to the Royal Institution of Chartered Surveyors – perhaps good news for homeowners but presenting new problems for first-time buyers, who are facing more expensive homes without being able to benefit from 2-3% rates.
While the impacts of slackening rates vary across groups and demographics, the most crucial factor for all mortgage owners will be the lag time between fixed-term deals ending and the pace at which the Bank of England decides to reduce rates. For those lucky enough to have taken out five-year fixed-rate mortgages in 2020 and 2021, regardless of near-term rate cuts, the jump by 3-4% in some cases will sting. Meanwhile, those already on higher or variable rates will see only light relief from the recent rate cut.
Remain seated
While we are in a better place than we were a few months ago, there is still a long way to go until we start to feel the benefits of a lower-rate environment. There is good reason for optimism, but we need to view the slow climb down with a dose of realism. Rates remain at their highest level since 2008 and a return to the ultra-low rates that dominated for over a decade are unlikely to return any time soon.
Lenders and borrowers need to understand this reality. It is therefore incumbent on lenders to communicate clearly with borrowers and prioritise customer care. While the economic mood is improving, mortgage costs will continue to weigh heavily on household finances and the risk of arrears remains high. Understanding and accounting for the diversity of borrowers and the nuances of their personal situations is essential. Lenders need to remain on their guard and operate under the assumption that mortgage costs will likely stay high for some time.
Unfortunately, the mortgage market will not return to its 2020 state at the snap of the Bank of England’s fingers. As one extraordinary period ends, another begins – there will be positive impacts of the slow reduction in rates, but there may also be unexpected consequences, especially in the Buy-to-Let market. The economic outlook is improving, but for lenders and borrowers, it is not plain sailing just yet.
1. https://www.ukfinance.org.uk/news-and-insight/press-release/mortgage-lending-fall-in-2024
2. https://www.finder.com/uk/mortgages/buy-to-let-statistics