There is concern that UK house prices are rising at an unsustainable rate. In the past 40 years, UK house prices have consistently grown faster than average earnings. (Why are UK house prices so expensive)
Even as the economy just begins to emerge from recession, the housing market is already showing signs of overheating. In some areas, house prices are rising 10% a year – much higher than CPI inflation of 1.6%.
Expensive house prices threaten the economy in various ways:
- Make many areas unaffordable for young people causing shortages of skilled labour.
- Increased wealth inequality between home owners and renters.
- An unsustainable boom in house prices could lead to an eventual fall in prices, with corresponding bank losses and negative wealth effect.
- See also: Problems of expensive house prices
How do interest rates affect house prices?
Interest rates were cut in 2008/09 – causing a a decline in the cost of mortgage payments
- Currently, in the UK interest rates are very low. Base rates, set by the Bank of England, are currently 0.5%. This has reduced the cost of mortgage payments, making buying a house relatively attractive.
- It means that despite the rise in house prices, mortgage payments are not too expensive. With interest rates so low, it make sense to try and buy. This increase in demand for housing is one significant factor in pushing up prices.
The effect of rising interest rates on the housing market
- If interest rates rise it will have a significant effect on increasing the cost of mortgages. This will deter prospective home-buyers, but it may also force some existing home-buyers to sell. The danger is that many homeowners are being protected by ultra low interest rates. If rates rise, this will make mortgage payments too expensive and they may be forced to sell.
- This increase in sellers and decline in buyers will cause house prices to fall.