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Need to Know: A tale of two housing markets

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Something curious is happening in the housing markets of the US and UK. While inflation is hitting the economies of both countries, and mortgage interest rates are far above the levels of two or three years ago, house prices are going in opposite directions in each country — rising in the US and falling in the UK. 

Part of the explanation lies in the structure and operation of the mortgage market and its effect on the behaviour of owner-occupiers and potential buyers. FT Money explores two very different housing markets. 

I thought both economies faced similar issues? 
There are definitely common themes. Central bank rates in the US and UK — which influence the cost of mortgage borrowing — are as high as they have been in more than a decade. In the US, the Federal Funds Rate has risen to around 5.5 per cent since the US Federal Reserve first started targeting higher rates in early 2022. In the UK, a similar strategy by the Bank of England has led base rates to rise from 0.1 per cent in December 2021 to 5.5 per cent today. 

Central bankers in both countries are trying to put a lid on inflation, which stood at an annual 3.7 per cent in the US in August and 7.8 per cent in the UK. 

But what about house prices? 
In the UK, higher rates seem to be feeding through to lower house prices. Lender Halifax last week said prices had fallen for the fifth consecutive month and at the fastest annual pace since 2009. Prices were 4.6 per cent lower last month than in August 2022, taking about £14,000 off the average value of a house — though the average is still higher than it was before the pandemic struck. 

When rates began to rise, US housing prices fell for a while, starting in June 2022. But since February, they’ve been on the rise again. In June they stood 45 per cent higher than pre-pandemic levels, according to the S&P CoreLogic Case-Shiller index update — erasing all the declines of the past year. The market is right back at its peak. 

Why the difference?
In the UK, most borrowers take out mortgages where rates are fixed for two, three or five years. Though a capital repayment loan typically takes between 25 and 35 years to pay off, they must refinance every few years when these fixed rates expire. 

These fixed rates have shot up over the past 18 months. Average UK mortgage rates are running at 6.5 per cent for a loan rate fixed for two years, compared with rates under 3 per cent in late 2021. 

US mortgage borrowers taking out a 30-year loan can lock in their rate over the full term of the loan, with no need to remortgage if they keep up their payments. 

In the UK, the need to negotiate another deal with lenders every few years means the latest rises in rates will feed through to borrowers over just a few years. But in the US, there is no such refinancing deadline. Homeowners who took out a 30-year mortgage at 2 or 3 per cent a few years ago are now seeing rates in the market above 7 per cent. 

This leads to the phenomenon of rate lock-in. Owners are strongly incentivised not to move, even if their family is outgrowing their home and they need a bigger house.

The result is that the stock of existing homes for sale — the bulk of housing supply — shrinks, further constraining the number of homes available for sale. And although high mortgage rates have curbed demand, some buyers still seem willing to absorb costlier mortgages. Reduced supply and relatively steady demand means prices go back up.  

For some US homeowners, the lock-in effect is a huge financial benefit at a time of rising consumer prices. But it also creates substantial rigidity in the market — and critics point to the difficulties it brings for young people, who remain locked out of the housing market by elevated prices. 

Ethan Wu is a financial reporter based in New York and hosts the twice-weekly Unhedged podcast. 

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