House prices and interest rates

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.


In 1990 and 1991, high interest rates caused a rise in home repossessions and was a factor behind the big house price collapse of the early 1990s.


  • It is important to bear in mind that interest rates are not the only factor affecting house prices. It is possible for interest rates to increase, but house prices continue to rise.
  • For example, if confidence is high and we experience a period of rising incomes then people may continue to buy, despite the rise in interest rates.
  • The supply of housing is also very important. A big factor in the current rise of UK house prices is due to the shortage of supply, which is pushing house prices higher.
  • However, in the current economic climate, we could expect higher interest rates to have a significant effect on reducing house price growth. Given low real income growth in the past few years, a rise in rates would have a big effect on household disposable income. The UK is likely to be sensitive to any change in interest rates.

House prices vs the rest of the economy

House price growth puts the Bank of England in a difficult position. The primary objective of the Bank of England monetary policy is low inflation and ensuring adequate economic growth. Currently CPI inflation is below target, unemployment is high and the economic recovery fragile. Given this situation, the Bank may be expecting to keep interest rates low until the recovery is stronger.

The danger is that if the Bank of England use monetary policy to control house prices it could stifle the economic recovery and cause low growth.

The chancellor has stated that the Bank of England should control house prices through using interest rates. (Osborne puts responsibility on Bank of England) But, arguably it is a mistake to rely on monetary policy to control house prices.

Alternatives to cooling the housing market

  • Revaluating the governments right to buy scheme – which has helped people get mortgages.
  • Controls on mortgage lending (e.g. limiting mortgages to 3* income)
  • Tax on second homes to discourage speculation.
  • Taxing unused homes.
  • Regulation  / tax on foreigners who purchase housing in the UK.
  • In the long term, reducing planning restrictions to enable increase in supply
  • Government returning to policy of building council homes.



2 thoughts on “House prices and interest rates

    1. If your annual income is £20,000 the bank is willing to lend £60,000 for your mortgage if 3 times income multiple.

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