How does inflation affect mortgage rates?
Find out how the Bank of England's inflationary measures can drive mortgage rates up or down.
12.08.24
Beth
When the Bank of England raises the bank rate (also known as the “base rate” or “interest rate”) to control UK inflation, mortgage rates may also increase. That’s because financial institutions use the bank rate to benchmark how much interest to charge for mortgages. If the bank rate changes, the lender may also adjust their rate by around the same amount.
There are quite a few factors in play whenever high inflation affects mortgage rates, so let’s look at each one in detail. We’ll even discuss some solutions if higher mortgage interest rates become unbearable.
How are mortgage rates linked to inflation?
Inflation measures how much prices have increased since the previous year, and the UK Government considers 2% a reasonable rate. But once inflation passes that 2% mark, the Bank of England must step in to bring it back down. One method they can use is increasing the bank rate.
Whenever the Bank of England increases the bank rate, mortgage rates also increase. That’s because most mortgage types follow the bank rate’s movement. How closely your mortgage rate follows the bank rate and how it affects your monthly payments will depend on your mortgage type.
Let’s take a look at how inflation affects each mortgage type.
Tracker Mortgage
If you have a tracker mortgage, your rate will closely match the current bank rate. Tracker rates are usually set slightly above the bank rate but “tracks” its up-and-down changes.
For example, a lender may offer a tracker mortgage rate that’s 1% above the current bank rate. If the bank rate falls by 0.5% the following month, your rate will decrease by the same amount.
Because tracker mortgage interest rates closely follow the bank rate’s movements, higher mortgage rates during inflation means your monthly payments also go up. Including mortgage payments in your budget for the coming months could be challenging because of higher prices.
On the other hand, a tracker mortgage is excellent when the bank rate goes down—that means your rate (and your monthly payment) goes down, too. Lower rates mean lower mortgage costs.
However, mortgage lenders have recently introduced a “collar rate,” which sets the lowest your rate could go if the bank rate is lowered significantly. For example, if the bank rate drops to 1.5% but your collar rate is at 3%, your monthly payment will stay at the 3% rate.
Standard Variable Rate Mortgage
A standard variable rate (SVR) mortgage is the lender’s default rate after a borrower’s limited-time tracker or fixed rate mortgage ends. Mortgage lenders set their own rates, so SVRs are always higher than the bank rate.
SVR mortgages don’t follow the bank rate’s movements as closely as tracker mortgages. If the bank rate changes it doesn’t necessarily mean the mortgage rate will. They could choose to keep it the same or change it more than the bank rate.
Budgeting your monthly mortgage repayments with an SVR mortgage can be tricky during inflation. Frequent increases in the bank rate affect how much you pay monthly. And even if the base rate goes down, there’s no guarantee you’ll get a lower rate.
Fixed Rate Mortgage
Unlike tracker and standard variable rates, fixed rate mortgage rates don’t change when the bank rate fluctuates. Borrowers keep the same rate throughout their fixed mortgage term, which means you can avoid higher mortgage rates during inflation. That means your mortgage repayment costs stay the same, allowing you to plan your budget accordingly.
On the flip side, if the bank rate decreases while you’re in the middle of your fixed rate mortgage term, you won’t get a lower interest rate.
For example, if you have a fixed rate of 4.85% and the bank rate decreases by 2.5%, your rate stays at 4.85% until the end of your term, which can range from 2 to 10 years.
You usually can’t change from a fixed rate to a variable rate unless you’re willing to pay a hefty fee, and the same applies if you intend to pay off the mortgage sooner.
Will a change in mortgage rates affect my credit score?
A change in mortgage interest rates will not affect your credit score; it only affects how much your monthly repayments will be.
However, your monthly payment history—whether you’ve paid on time or missed any payments—is on your credit report. If you miss a payment because your mortgage rate has increased, that could affect your credit score.
If you’re experiencing difficulties due to higher interest rates, the Government, the Financial Conduct Authority (FCA), and the banks have agreed a Mortgage Charter which allows for the following support without any significant impact on your credit score:
Switch to an interest-only mortgage for six months
Extend your mortgage term to lower your monthly payments, then go back to your original term within the first six months
Your lender may offer other forms of mortgage support, though it could affect your credit score.
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What can I do if I can’t afford my monthly mortgage payments?
If you’re having trouble making your monthly mortgage repayments, here are some solutions you can try to prevent the problem from getting worse.
Contact your lender
If you’re experiencing difficulties due to higher mortgage rates, contact your lender as soon as possible. Don’t wait until you’re in arrears before seeking assistance.
Asking for support from your lender won’t impact your credit score, but missing your payments will. Depending on your circumstances, you may be able to agree to:
Extend your mortgage contract to lower your monthly payments
Pay only the interest for a set time
Defer payments temporarily (this could impact your credit score)
Other payment arrangements that suit your budget (this could impact your credit score)
Get free debt advice
If you have multiple debts, it can get out of hand quickly, especially when interest rates and monthly repayments increase. If you’re in this situation, you can get free and impartial debt management advice from services and charities such as:
MoneyHelper.org.uk has a debt advice locator tool to help you find online, telephone, or face-to-face debt advice services near you.
See if you’re eligible for government assistance
Depending on your situation, several government assistance schemes are available to help you with your mortgage payments. Some of these programmes include:
Turn2Us has an online tool for determining which government benefits and grants you can get depending on where you live and your current situation.
Recap: How does inflation affect mortgage rates?
When the inflation rate is high, the Bank of England will try to curb it by increasing the bank rate. When the bank rate increases, so do mortgage rates.
Depending on your mortgage type, your rate may closely follow the bank rate’s movements. Tracker and standard variable rate mortgages fluctuate based on the current bank rate, meaning your monthly payments may not stay the same. You’ll see this effect more on tracker rate mortgages because they “track” the bank rate’s movements.
On the other hand, fixed rate mortgages stay the same regardless of the current bank rate. This stability can provide security during periods of inflation (when interest rates are high) by keeping your monthly payments constant. However, your rate also won’t change if the bank rate goes down.
Frequently Asked Questions
What is inflation?
Inflation is the rate at which prices increase over a certain period, typically a year. The Office for National Statistics (ONS) tracks the prices of general consumer goods monthly and compiles the data into several price indices:
Consumer Prices Index including owner-occupiers’ housing costs (CPIH)
Consumer Prices Index (CPI)
Retail Prices Index (RPI)
The Government has tasked the Bank of England to keep the target inflation rate at 2%. Once it exceeds that number, the Bank of England must take monetary policy measures, such as raising the bank rate, to decrease UK inflation.
Why does the Bank of England need to increase the bank rate?
To lower the inflation rate, the Bank of England must increase the base rate until spending and price rises slow down; sometimes, this means several rate increases within a year. That means mortgage rates and other interest-based products also increase.
Uncontrolled inflation leads to hyperinflation, which can have disastrous economic consequences.
What happens when the Bank of England increases the bank rate?
Increasing the bank rate does two things:
Increases interest rates on loans
Higher returns on savings accounts
The idea is that by making it more expensive to borrow and more profitable to save, people will spend less and save more. Businesses are more hesitant to raise prices when people don’t spend as much. When price rises are slower, the inflation rate lowers.