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The Bank of England raises interest rates to 5%, heightening concerns of a’mortgage bomb’

After statistics this week showed unusually tenacious inflation, the Bank of England increased interest rates by 0.5 percentage points on Thursday. The action will add insult to injury for mortgage holders and further drag down home values.

The rate at which commercial banks in the United Kingdom borrow money has increased for the thirteenth straight time, reaching a record high of 5% in April.

The economy is performing better than anticipated, but inflation remains too high and must be addressed. Andrew Bailey, governor of the Bank of England

We recognize the difficulty of this and appreciate that many borrowers have concerns about their financial futures as a result. However, he cautioned that things can get far worse if interest rates aren’t increased right away. We are determined to reduce inflation back down to the 2% goal and will take the necessary measures to do so.

The markets believe that the Bank of England’s benchmark interest rate will rise to 6% sometime next year, a level not seen in two decades, as the central bank fights increasingly more desperately to slow inflation.

That’s bad news for the almost 2 million people in the UK who have mortgages since they’ll have to refinance this year or next and see a significant hike in their monthly mortgage payments.

The people are tremendously worried about the mortgage bomb ready to go off, Conservative MP Jake Berry said on Tuesday in parliament.

Lawmakers were informed by Finance Minister Jeremy Hunt that he will be meeting with key lenders this week to discuss ways in which they may assist borrowers who are having trouble making their mortgage payments.

The UK economy has so far avoided a recession, but rising mortgage rates are expected to reduce consumer spending and increase the likelihood of a worse economic contraction.

Official statistics released on Wednesday revealed that inflation remained unchanged at 8.7% in May, confounding projections for a tick-down, leaving the Bank of England with no choice but to raise rates.

And contrary to what has been happening in the United States and Europe, core inflation (which excludes the more volatile expenses of food and energy) increased last month, reaching a 31-year high of 7.1%.

Prime Minister Rishi Sunak is under more scrutiny after inflation data came in higher than predicted. Sunak had pledged to voters that he would cut inflation in half this year, to roughly 5%.

An “unprecedented mortgage crunch”

UK mortgages typically have a shorter term than those in the US; the most frequent terms are two and five years. Many homeowners who are currently paying mortgage interest rates north of 4% are planning to refinance this year or next when they drop back down to the 3% range.

The average cost of a fixed-rate mortgage for two years has risen beyond 6% this week, the highest level since the beginning of December, according to Moneyfacts, a website that compares various financial products.

If interest rates stay where they are, homeowners will pay an extra $280 ($357) a month on their mortgages compared to what they were paying in March 2022. Those in the 30-39 age range will pay an additional £360 ($459).

There will be more and more families forced to tighten their belts in the future.

According to UK Finance, around 800,000 fixed-rate mortgages will mature in the second half of 2018. There will be a need to refinance another 1.6 million mortgages at much higher rates in 2019.

In a study, Simon Pittaway, a senior economist at a think tank called the Resolution Foundation, said, “The latest changes in market interest rates suggest that a bad situation for UK mortgage holders has just gotten worse.”

A prolonged and historic mortgage crunch is in store for UK families if interest rates rise as predicted.

Home prices will decline further.

The recent increase in mortgage rates will have a negative impact on homebuying activity and, in turn, home values.

“So far, the housing market hasn’t seen any material change in behavior, although anxiety levels are rising,” said Tom Bill, head of UK residential research at real estate brokerage Knight Frank.

According to Knight Frank, national home prices will drop by 5 percent this year and another 5 percent in 2019.

Wage increases, which have become a major factor in UK inflation and, by extension, interest rates, will help the property market.

While rising wages are a major negative influence on the housing market, Bill assures his audience that they will also help to cushion the blow of any fall.

Other mitigating factors include the fact that many homeowners already own their homes entirely and the savings that households collected throughout the pandemic. When borrowers are having trouble making their payments, banks are more inclined to show restraint and try to work with them.

Bill predicted that the market will not be hit by a flood of repossessions and foreclosures, which might lead to a precipitous decline in prices. “Banks will show some leniency.”

According to research by Capital Economics, only over 30% of UK families currently have a mortgage, down from 40% in the 1990s.

Senior property economist Andrew Wishart noted a trend toward longer loan terms of 35 or 40 years rather than the more traditional 25 years. This has the added benefit of lowering mortgage payments on a monthly basis.

Between their high in August 2022 and 2024, home prices are predicted to fall by 12%, according to a report by Capital Economics.

A steeper decline in home values is possible if interest rates need to remain higher for a longer period of time in order to curb inflation. Wishart predicted that home prices would drop by 25% if mortgage rates remained at 6% for several years.

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