The role of debt 

A longer-term fix 

The last time we saw anything like double-digit inflation in the UK economy, special agent Dale Cooper was investigating the murder of Laura Palmer, as the cult drama Twin Peaks hit our screens in 1990. With owls that were not what they seemed and a woman cradling a log, it was out of the ordinary to say the least.

Fast forward 32 years and Stranger Things is now the go-to fantasy drama. But now it’s not just the inhabitants of the Midwestern town of Hawkins who are experiencing the extraordinary, as the prime housing market faces up to a brace of post-pandemic economic challenges.

From this economic perspective, supply shortages – initially a consequence of the pandemic – have been compounded by the war in Ukraine. Inflation has month-on-month surpassed economists’ expectations and the Bank of England has imposed seven successive rises in interest rates. 

The increase in the cost of living and higher costs of debt mean that most homebuyers face much higher mortgage costs. This comes at a time when their household bills, most notably the cost of energy, are heading north faster than an Aston Martin travelling up the M1.

Less exposed – but not immune

The top end of the housing market is not immune to these pressures, but neither is it exposed to them in the same way as the rest of the housing market. As a rule, personal wealth and accumulated equity play a much greater part in funding house purchases the further you go up the value scale.

Indeed, data from our own deal book suggests a 50:50 division between mortgaged and cash buyers in the market above £1 million across 2020 and 2021. While analysis of ONS data from the Regulated Mortgage Survey indicates it may have been closer to 60:40, in both cases this represents an increase over previous years. This is partly because the price growth seen over this period brought more mortgaged buyers into this price bracket. But it is also because buyers actively locked into the low costs of mortgage debt available.

Where equity rules

The use and reliance of mortgage debt also varies across different parts of the market. For example, our deal book data indicates that only around one-third of buyers used mortgage debt to finance their purchase in the markets of prime central London. And in many cases the use of this debt will have been discretionary or driven primarily by tax considerations. 

By contrast, in the more needs-based markets of South West London and prime suburban markets such as Cobham, Loughton and Northwood, debt supports two-thirds of purchases in some way, shape or form. 

Further away from London, equity again has a greater part to play. Yet, as our supplementary analysis of ONS data across all price bands in the most aspirational local authorities shows, there are nuances between different locations that will determine how different parts of the market react.

Running up that hill

What, then, does this all mean for the prime market?

Recent and prospective future rate rises will undoubtedly mean a reduction in buying power for those using debt. This points to a period of greater sobriety across the prime market, partly as weaker buyer sentiment feeds up into higher price bands.

This reduced buying power can be put into context by our worked examples of buyers using mortgage finance to acquire a four-bedroom property in prime South West London and the prime regional markets. Both show a steep rise in monthly mortgage payments because of the recent rate rises. But that comes off of a low base. But having regard to underlying levels of historical inflation, the relative cost of mortgage payments is currently some distance away from where we were in, say, 2007 when affordability was looking stretched, leaving the market exposed to the economic events that followed.

That leaves some, but not unlimited, capacity for further rate rises to be absorbed by the market. As interest rates have risen, so have the prospects of a fall in prime property prices over the next 12 months. While the Bank of England has made clear that it will not hesitate to take further measures to curb inflation over the short term, once that takes effect consumer price inflation should fall back towards the Bank of England’s 2% target at some point, allowing rates to be gradually reduced once economic pressures ease.

So as we await the final instalment of Stranger Things, we expect to see a weakening in prices in the domestic prime markets in 2023, eroding the gains of the past two years, before a step-by-step return to price growth over the medium term.

Data from the mortgage broker SPF gives us a further insight as to the way buyers have used mortgage debt in the market over £1 million during the past few years. It shows borrowers in the prime market generally sitting on a sizeable equity cushion and have altered their borrowing strategy to reflect changing market conditions. It indicates that, at the point of purchase, the average mortgage has equated to 62% of the acquisition price of a property. Among those remortgaging, this average loan to value falls to 47%, with 57% of those refinancing seeking a mortgage of less than half the value of their property.

It also tells us that since 2020, borrowers have been more inclined to fix, and fix for longer, reducing their exposure to recent interest rates rises. While that has primarily been evidenced in a shift to five-year fixed-rate mortgages, our most recent client and applicant survey shows that before the events of late September, borrowers were increasingly wanting to fix for longer. At that time, some 13% of respondents who were looking to finance their next purchase with a mortgage stated a preference for a 10-year fixed-rate deal. Doing so in the future will depend on the availability and cost of taking this option, suggesting that in many cases such plans will be put on hold until the mortgage markets settle down.

As rates have risen, so we have also seen buyers take advantage of more flexibility in the market regarding repayment terms. As a result, lending on prime property was broadly evenly split between those on an interest only, part repayment and full repayment mortgage in the first eight months of 2022. As we go forward, this kind of flexibility is likely to be increasingly valued by borrowers, right across the housing market.