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How does inflation affect your mortgage?

This guide was last updated 9 June 2022

As has recently been reported, in April 2022 inflation hit a near thirty year high of 9% and could well rise even higher during 2022.

The rise in inflation will have an impact not just on the economy, but on the general standard and cost of living. One of the most concerning consequences of the rise of inflation is the effect high inflation has on mortgage repayments.

What is inflation?

Inflation is basically the rate at which the prices of goods and services have increased over the previous twelve months. It’s measured in a number of ways with the Consumer Prices Index (CPI) and the Retail Prices Index (RPI).  Both indexes measure the prices of general consumer goods and services comparing them to a year earlier. The change in those prices is expressed as a percentage – for instance, if the CPI is at 2%, then prices for the ‘basket’ of goods and services are, on average, 2% higher than they were the previous year. Both CPI and RPI look at products like groceries and petrol as well as services such as eating out, utility bills and mobile phones, but the RPI also includes certain housing costs and mortgage repayment costs.  The government now uses the CPI as its inflation index and it does not include house prices or mortgage repayments.

How does inflation affect my mortgage?

Inflation has a significant impact on government and business decisions. The Bank of England keep a very close eye on inflation and use it establish interest rates. If they expect inflation to rise above 2% in the near future, then they may increase interest rates in an attempt to subdue it and discourage businesses from increasing prices any more than they have to. Or, if they expect inflation to drop much below 2%, they might reduce interest rates to make borrowing cheaper, enabling consumers and businesses to spend more, which can invigorate an economy. For this reason, inflation has a critical effect on the price you pay for a mortgage. If interest rates go up in order to counter inflation, anyone looking to get a new mortgage will have to pay more interest than they would have if they had applied before the interest hike. Alternatively, if you are currently on a tracker mortgage, then you can expect your monthly payments to go up the month after the Bank Of England increases the base rate.

Currently (June 2022) the Bank Of England is in the middle of a cost of living crisis and are increasing the base rate not so much to combat inflation now but to stop it from staying higher any longer than necessary. As the base rate is expected to increase further over the remainder of 2022, and possibly into 2023, we are seeing lender’s mortgage rates increase broadly in line with expectations.

Is there anything I can do?

The main defence against inflation rises is to get a fixed rate mortgage. These work as insurance against interest rises by establishing a set level of interest for your repayments that won’t change for a set period of time – usually 2 or 5 years but there are other terms available. The gamble on these is that they tend to be more expensive than variable or tracker rate products, and if interest rates actually go down, you won’t be able to take advantage of the savings. Fixed rate mortgages are usually calculated on expected interest rates calculated by the bank, so you will be relying on their expertise to give you the best deal.

The best way to prepare for inflation is to do your research and/or talk to a professional. Here at Coreco we have seen – and predicted – inflation rising and falling, so we have the expertise to guide anyone worried about what kind of mortgage they should get, or wanting to know how inflation will affect their circumstances. Why not get in touch? We’d be very happy to hear from you.