Anyone wishing to buy or sell a house should know the background of interest rates in the property market. The housing market is greatly shaped by interest rates, which the Monetary Policy Committee of the Bank of England sets. These rates have changed greatly over time, affecting house prices and mortgage rates.

What Are Interest Rates?

Interest rates represent the expense of borrowing money. The interest rate on a mortgage decides the extra payment you will make on top of the main loan (the capital). Lowering interest makes borrowing money less expensive.

However, interest rates play a dual role. Lower rates mean that investments and savings accounts provide less return, which might affect decisions about spending and saving. Thus, managing your borrowing and savings plans depends on knowing interest rates.

Who Sets the Interest Rates?

Setting interest rates falls to the Monetary Policy Committee (MPC) of the Bank of England in the United Kingdom. Comprising nine members, this committee convenes often to evaluate the state of the economy and decide if the base rate should be changed. In fact, MPC maintains price stability by controlling inflation. The MPC bases its judgements on careful study of several economic indicators, including general economic growth, inflation rates, and employment numbers.

By changing the base rate, the MPC wants to influence borrowing and spending patterns across the economy. Therefore, MPC supports steady prices and sustainable development. Setting interest rates is a strategic as well as a scientific activity. That’s why forecasting economic trends and acting ahead to prevent inflationary pressures or economic downturns is part of it. This dynamic method aims to safeguard the economy from significant swings and help to smooth out economic cycles. 

A Brief History of Interest Rates

The Early Years

Let us begin with some background. The UK had some exceptionally high rates in the 1970s and 1980s. For instance, the base rate peaked shockingly at an amazing 17% in 1979. These high rates were mostly used as a weapon to fight the then-dominant runaway inflation.

The 1990s and Early 2000s

When we fast-forward to the 1990s, we witness a change. Interest rates started to settle and progressively dropped. The base rate was roughly 10% in 1992; by the early 2000s, it had reduced to roughly 4-5%. Reduced rates made mortgages more reasonably priced and stimulated the property market.

Post-2008 Financial Crisis

The financial crisis of 2008 was still another major turning point. The Bank of England cut interest rates to record lows to boost the economy. The base rate by March 2009 was just 0.5%. For those that borrowed, this was fantastic news since it meant far smaller mortgage payments. But it also resulted in fast-increasing property prices since more individuals could afford homes thanks to cheap borrowing.

Recent Years and the Present

Interest rates have had some swings recently. Another dip is a record low of 0.1% in March 2020 brought about by the COVID-19 epidemic. The Bank of England has had to raise rates several times nonetheless, as inflation is once again growing. The base rate right now (July 2024)  is 5.25%; it has been highest in more than ten years.

What Do Rate Changes Mean for Mortgages?

Rising Interest Rates

When interest rates go up, borrowing becomes more expensive. For homeowners with variable-rate mortgages, this means higher monthly payments almost immediately. Even those on fixed-rate mortgages will feel the pinch when their fixed term ends and must remortgage at higher rates. This often leads to a cooling of the property market, as fewer people can afford to buy, and house prices may stabilise or even fall.

Falling Interest Rates

Conversely, borrowing is less expensive as rates drop. This is fantastic news for purchasers and could cause home sales to rise, therefore increasing house prices. For current homeowners who can remortgage at reduced rates, it also helps to minimise monthly payments and free up spare cash.

To illustrate how different interest rates affect your mortgage payments, let’s consider a real-world example. Suppose you’re looking to borrow £250,000 for a home with a mortgage term of 25 years (repayment). Here’s how much you would pay monthly at various interest rates:

• At a 3.0% interest rate, your monthly mortgage payment would be approximately £1,185.53.
• At a 5.0% interest rate, your monthly mortgage payment would increase to about £1,461.48.
• At an 8.0% interest rate, your monthly mortgage payment would rise significantly to around £1,929.54.

These calculations prove the significant impact that interest rates have on your mortgage payments. As the interest rate increases, the monthly payment can rise sharply, which affects your affordability and long-term financial planning.

The Big Picture: Impact on the Economy

The wider economy is intimately related to the property market and interest rates. Rising consumer spending results from homeowners feeling richer and more confident about high property prices. Conversely, should housing prices decline and interest rates rise, consumer expenditure may decrease, therefore causing an economic slowdown.

Whether your goal is to buy, sell, or just plan for your mortgage, knowing these patterns can enable you to make smarter choices. Watch the statements from the Bank of England since changes in the base rate can have a big effect on your finances – for better and for worse.