We are back in the late 80’s – war, high inflation, and high-interest rates – A housing market crash to follow as well?

Last autumn, I compared our current situation to the one the UK faced in the late 1980s. The rising interest rates and the oil crisis due to Iraq’s invasion of Kuwait led to high inflation and a housing market crash, where house prices fell by 20% between 1989 & 1993. We have had the Ukraine war, persistently high inflation and interest have risen at the fastest on record. Does this also mean we will likely see a similar housing market crash to the one in the late 80s?

It is not particularly a great time if you have a mortgage as rates continue to rise, and experts are now forecasting the base rate to reach 6%. The financial conduct authority estimates that 2.3 million households will need to re-mortgage by the end of this year. Adding an average of £3,300 to their mortgage repayments annually.

According to Capital Economics, 145,000 homeowners are expected to fall into arrears as a result, and it estimates that in 2025, the number of homes repossessed will reach its highest level since 2014.

The average mortgage rate for a two-year fixed on a residential mortgage has risen to 6.15% for a two-year fixed and 5.79% for a five-year fixed, according to Moneyfacts (Rates correct as of 22nd June). However, the rates will continue to rise after the inflation data published by the ONS yesterday showed that inflation remained unchanged at 8.7%, well above the BOE’s target.

Mortgage rates at 6%, likening to the pain of the 1980s:

Mortgage rates reaching 6% are likely to cause similar pain to the 1980s, even though the bank rate at the time was at 13%. This is because borrowers today have bigger mortgages compared to the 1980s and much lower incomes. The average house price has reached £286,000, and the average UK salary is £33,101. This means the average house price is almost nine times the average earnings. Compare this to the late 80s; house prices were five times the average salary before they crashed. When repayments surged in the late ’80s, it equated to around £1,200 in today’s money. The rate increases now will be 2.5 times that, indicating that the mortgage crisis this time is likely to be worse than in the late 80s. 

Aneisha Beveridge, head of research at Hamptons, says that average mortgage rates of 6% will mean that proportion of people’s income spent on their mortgage will return to the levels not seen since the late 1980s. While wages have risen by 94% since 2000, house prices have increased by 224% at their peak in 2022, causing borrowers to take out bigger loans for increasingly longer terms of 30,35 or even 40 years.

According to Roger Bootle, chairman of Capital Economics, the average size of mortgages in relation to average earnings would be two times what it was 25 years ago, which could double the impact of mortgage rate rises. The graph below highlights that the estimated change in annual mortgage payments has doubled since the late 80s. This is likely to cause severe pain because the level of mortgages is so high.

Roger Bootle also warns that we have had more significant rate increases before but with a lower level of indebtedness, which is a serious concern.

Will all this mean a housing market crash will be worse than the late 80s?

Not quite; one of the positives to this compared with the late 80s is that rising rates will impact fewer people because more people have fixed-rate deals than they did in the 80s or 90s, and older people are more likely to be mortgage free. There will also likely be fewer home repossessions for those who fall behind on payments than in the late 80s and ’90s because borrowing is more regulated today. For instance, there are no 110% or 125% mortgages today, and people must prove earnings before borrowing.

And one of the biggest reasons why a housing market crash will not be as bad as the late 80s is that the unemployment rate in the UK is at its lowest on record at 3.8% compared to the late 80’s the unemployment rate topped at 10.6%. Wages are growing at their fastest rate enabling households to combat some of the inflationary pressures. This will lead me to conclude that house prices will fall due to the affordability crunch as a result of higher interest rates but nowhere near the levels of the late 80s.

A 10-12% decrease is more likely than a 20% plus.

It is the buy-to-let sector that will struggle the most: 

However, one of the sectors that will suffer is the rental sector; the pressure on renters will be more acute as supply will take a severe hit over the next few years. Analysis done by estate agency Hamptons shows that when interest rates reach 6.5%, 44% of mortgaged landlords will need to make more from rent to cover their costs. This would rise to 54% if the average rates reached 7 per cent, as the graph below highlights.

As interest rates increase, more and more landlords will be unable to meet their mortgage payments, forcing them to either sell or increase rents exponentially. The graph below highlights that the rental demand in June across the UK was up by 57% compared to the five-year average, and supply was down by 28%. Demand will likely continue to increase, and supply will diminish, causing more misery for renters.

The government will have no choice but to intervene in the private rental sector and encourage more landlords to invest. The policy around the private rental sector needs reform, as previous government interventions have only made it worse. Capping rents will not work, as is highlighted by the case of Scotland. Last year, The Scottish government capped rent, which made things worse on the supply side and increased rents at their fastest rate. As the graph below shows, Edinburg and Glasgow were amongst the top cities to see rental inflation exceed 10% because of the Scottish government policy. I see no other option but for the government to intervene over the next 12 months to support the private rental sector, or it risks a serious rental crisis.

The current mortgage crisis will soon result in a rental crisis as homeowners still have a lot of support. The risk as I see it over the next 12 months lies with those who have low equity mortgages, i.e., 5-10% Loan to value mortgages, as they risk falling into negative equity, meaning that their house will be worth less than the outstanding mortgage making it harder for them to sell. Along with the private rental sector as more and more landlords will fall into the red due to the interest rate rises.

A housing market crash like that of the late 80s is unlikely as wages are growing at their fastest rate and the unemployment rate at a record low. However, the next 12-18 months will be very turbulent for the housing market.