Throughout 2024, many home owners and prospective first-time buyers would have kept a close eye on the Bank of England's base interest rate . Eventually, the first cut arrived in August (from 5.25% to 5%), followed by another drop to 4.75% in November .
Author
- Alper Kara
Head of Department - Economics and Finance & Professor of Banking and Finance, Brunel University of London
Those changes were in line with market expectations . But they were not enough for many households feeling the economic squeeze.
For example, the average mortgage lending rate for a typical first-time buyer (based on a two-year fixed rate with a 10% deposit) was around 5.4% in both January and November 2024.
And the full impact of higher mortgage rates, which began rising in late 2021, has not yet been felt. The Bank of England expects that around 50% of mortgage holders (approximately 4.4 million households) will have to switch to higher rates between now and December 2027.
Of these, an estimated 2.7 million borrowers will experience rates above 3% for the very first time. Around 420,000 households will face monthly payment increases of more than £500.
There is some good news in the latest projections which suggest that by the end of this year, the Bank's base rate will drop to around 3.75%. An estimated 2.4 million borrowers will then see a drop in their monthly mortgage payments.
Banks and building societies are also expected to increase mortgage lending by 11% in 2025, as affordability constraints ease with falling rates and rising real wages. Some major lenders have already started the new year by announcing marginal reductions. Others are likely to follow suit.
But that may be as good as it gets. The recent rise in the UK's annual inflation rate to around 2.6% is troubling, for example. Inflation is expected to remain above the Bank of England's 2% target throughout 2025, which could slow the pace of rate cuts.
Another downside, particularly for first-time buyers, is the continued increase in UK house prices. Over 2024, they increased by 4.7% , with the average price now £270,000. So gains from reduced mortgage rates could be swiftly cancelled by the increasing pressure on housing affordability .
There are also signs that households are being cautious with their home purchase decisions as mortgage demand dropped unexpectedly after the government's budget of November 2024 .
The effects of that budget are still coming into play, but early signs are not promising, as the economy is expected to show zero growth for the second half of 2024. For 2025, the predictions for UK economic growth is 2% at best.
Tariffs and Trump
One of the controversial policies introduced in the budget was the rise in employers' national insurance contributions - which could have a couple of knock-on effects for mortgage holders.
First, the increase in cost to businesses could be passed on to households as price increases . This would put further pressure on inflation, and could affect interest rate decisions. Second, it may slow down wage growth, making houses even harder to afford.
Another risk in 2025 is that the UK's sluggish economic growth could lead to reduced tax revenues . If that happens, the government may face having to raise taxes again or resort to additional borrowing. Government borrowing costs have risen sharply since the budget, and further borrowing could exacerbate this trend.
This is significant for mortgage borrowers, as government borrowing costs serve as a key indicator of overall interest rate levels in the economy. As a result, mortgage rates may follow a similar trend.
There are also economic uncertainties linked to Donald Trump's return to the White House. There are predictions that UK economic growth could even be halved if the returning president Trump follows through on his proposed trade tariffs, significantly reducing UK exports to the US.
Other global risks include the potential for retaliatory trade wars which could exacerbate global inflation and drive up interest rates further.
One small piece of good news for UK home buyers has been the prime minister's commitment to build more affordable homes in the next four years. Such a move will certainly help, and could slow down house price increases.
However, these plans are likely to stall as it is much more costly for builders to build new houses on the targeted "grey-belt" areas. And the UK still faces skills shortages in things like bricklaying and carpentry.
Overall then, for anyone with a mortgage, and anyone hoping to get hold of one, 2025 looks full of uncertainty. And while the political and economic winds do not look particularly favourable, those all important interest rates will dominate many people's biggest life decisions for another year.
Alper Kara does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.
