Earlier this week we published an outlook for UK house prices. Now we look at mortgages, a key driver of housing market activity. Without the £1.7 trillion of mortgage finance, the whole ecosystem can’t function effectively. And that financing suddenly got more expensive in 2022 after a rapid increase in interest rates. While mortgage rates started to fall in 2024, there are some risks to the narrative that affordability will improve significantly this year. A surprise curveball has come from the UK government bond market in recent weeks.
This article looks in detail at how mortgage pricing works and the challenges facing potential homeowners in 2025.
Official interest rates are very closely watched for those looking to finance a house purchase, or remortgage this year. The Bank of England is expected to cut interest rates in February, from 4.75% to 4.50%, a move supported by the latest inflation data.
Mortgages should become cheaper in this scenario. Those with tracker products, which follow the movements in the Bank of England rate, should see a benefit, or at least after lenders change their rates. In the era of low and falling interest rates seen since the financial crisis of 2008, tracker mortgages became popular.
The flipside of trackers became obvious when the Bank of England started hiking borrowing costs from December 2021 to August 2023, when interest rates rose from 0.1% to 5.25%. A product that tracked the market down could also track it up, and that process happened swiftly.
In 2024 rates were cut twice, taking interest rates to 4.75%, but this is still similar to levels seen in 2008. There are forecasts of between two and four rate cuts scheduled for 2025, so official rates could end the year between 3.75% and 4.25%. Financial markets are currently expecting one or two cuts, so this would provide some relief to those taking out new mortgages or re-mortgaging, but not significantly.
Iain McKenzie, chief executive of the Guild of Property Professionals, said after the latest official ONS house price figures from November, published Jan. 15: “With mortgage rates still elevated, all eyes will be on the Bank of England, with many hoping for a rate cut at the next meeting in February.
“This should spur sentiment in the market and will hopefully have a knock-on effect on mortgage rates.”
What About Fixed-Rate Mortgages?
Fixed-rate products still make up the majority of new mortgages taken out, with “two-year fixes” a popular trade off between 24 months of payment certainty and not locking in to unattractive rates for too long.
Five-year fixed products became popular in the low-interest rate era. People liked the certainty of knowing their monthly payments would remain the same for five years, and they had “locked in” cheaper borrowing. Longer fixed-rate products such as 10 and even 20-year products are common in Europe and the US but have been slow to catch on here.
Those with existing fixed-rate products won’t see any change when/if the Bank of England cuts rates in because they’ve agreed to pay a certain rate in advance. They may benefit when the product expires, though and start on a new product.
New borrowers of fixed-rate products will benefit from lower interest rates this year because lenders will then adjust their rates downwards.
They may have already benefited in this scenario because financial derivatives markets price in interest rate expectations ahead of time; so the potential February cut may already be factored in to a mortgage taken out in the last few weeks.
Here’s where it gets complicated: while floating rate/tracker mortgages should fall this year, recently fixed-rate products have started to rise. Morningstar Investment Management recently wrote to clients about the recent gilt yield spike and the knock-on effect on the mortgage market: “Interest rates on new mortgages are also rising, calling affordability into question for new homeowners”.
Recent bond market volatility has also had an impact on fixed-rate mortgage products. This is because fixed-rate mortgages are priced off the Sterling Overnight Index Average, or SONIA, a benchmark run by the Bank of England that reflects the rate that banks lend and borrow to each other.
SONIA rates try to predict where interest rates will be over certain time periods such as in two years' time. And government bond yields are reflecting concerns over higher inflation and interest rates in the next few years, among other factors like government tax and spending plans.
More Uncertainty for Borrowers
David Hollingworth, associate director at L&C Mortgage, said that recent rises in fixed-rate mortgage products have added an extra layer of uncertainty for borrowers.
He suggests that the latest inflation and house price ONS figures, published on Jan. 15, will help to maintain some stability in mortgage rates, but says that time is of the essence:
“Borrowers coming to the end of their current deal are still likely to want to secure a new rate a few months ahead of time. That will allow them to dodge any further increases if fixed rates continue to rise but still gives them room to review if things take a turn for the better.”
The UK mortgage market is frequently described as “competitive”; in reality this means there are many products to choose from and prices are always under pressure. Currently the best product available on Money Saving Expert is a five-year fixed rate mortgage 4.18%. Attentive readers will notice this is below the official current interest rate of 4.75% and “tracker” mortgages are currently priced around 5%.
Borrowing Costs Remain High, House Prices Keep Rising
Alice Haine, personal finance analyst at Bestinvest, says there are no guarantees for borrowers of a sudden improvement in affordability.
“The average cost of a new fixed-rate mortgage has been volatile since the Budget, with some lenders repricing their products to reflect shifting interest rate expectations. With inflation potentially edging up further in the coming months, this would only prolong the pain for borrowers hoping for some respite from sky-high payments.
“Buyers and sellers will now be on tenterhooks to see when the next interest rate cut might materialize. For now, borrowing costs remain relatively high and with the mortgage market mired by uncertainty, first-time buyers and existing homeowners looking to secure a new deal soon may be feeling on edge.”
There are other dynamics at work in the mortgage market: affordability in one factor that varies significantly. The more you earn, the more you are likely to be able to borrow. And the better your credit rating, the more likely it is you will be able to access the “best buy” mortgage rates. Just because a competitively priced rate is available, doesn’t mean you will be able to access it.
Much depends on the value of the property you intend to buy, your salary and take-home pay and your credit rating. And as our house price preview this week shows, rising prices mean homeowners need to borrow more money, potentially negating some of the benefits of lower borrowing costs.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
