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What is the inflation rate and how does it affect your mortgage?

By
Jenni Hill
Last Updated 24 January 2024

Everyone seems to be talking about inflation right now, whether you’re scrolling through TikTok or chatting to the barman in your local pub. It can be hard to avoid it. It’s most visible in our bank accounts and wallets, the cost of filling up our cars or heating our homes, or the weekly trip to the big Tesco.

But what does inflation rate actually mean and how does inflation affect mortgage rates? Let’s explore how it works and what you can do to reduce the cost of your mortgage.

In this guide

What is inflation and how does it impact mortgage interest rates?

What is the inflation rate?

The inflation rate is the measure of how much the price of products or services has increased over time. For example, if a loaf of bread cost £1 today and £1.05 this time next year, annual bread inflation would be 5%. The changes in price from one month to the next is used to calculate the UK’s inflation rate.

To work out the inflation rate, the Office for National Statistics (ONS) tracks the prices of everyday items by creating an imaginary ‘basket of goods’. This is known as the Consumer Prices Index (CPI), but you might also see it as Consumer Prices Index including housing costs (CPIH).

The basket is regularly updated to ensure it’s an accurate reflection of consumer behaviour. In 2022, meat-free sausages, sports bras, pet collars, and antibacterial surface wipes were added to the basket, while doughnuts and men’s suits were removed. (We wish we had the willpower to remove the doughnuts from our own shopping baskets!)

What is the current inflation rate in the UK?

The latest inflation figures are from October 2023, which show that the current inflation rate (CPI) in the UK is 34.0%. This is a slight increase from the month before, which surprised City expectations who had been expecting inflation to fall. This surprise uptick was fuelled by alcohol and tobacco prices rising, largely caused by the increase in tobacco duty after the government announced higher taxes in their autumn statement.

However, this doesn't mean prices are declining, simply that the cost of goods is still increasing but at a lower rate than a few months ago, you'll still see prices going up in the shops. For example, overall food prices are still up annually by 8.0%, although rising less rapidly than in October, when they were up by 10.1%.

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For the first time in almost two years, average earnings are rising faster than inflation. According to ONS data, the annual regular pay growth was 6.6% from September to November 2023, which is one of the largest growth rates seen since records began in 2001. However, when you adjust this with inflation in mind, for the same time period regular pay only rose by 1.3% year on year.

When a person’s wages fail to keep up with inflation, they’ve effectively been given a pay cut. Even though their pay is higher than it was before, it won’t go as far if the cost of food, clothes, energy, petrol, and other living expenses has risen at a much faster rate.

The erosion of people’s available income has a huge impact on individuals and society. Rising inflation has been a driving force behind the recent strikes across the UK, where nurses, teachers, paramedics, and railway staff have demanded pay increases.

How does inflation affect mortgage rates?

When inflation rises dramatically, the Bank of England looks for ways to reduce it. One of the most common strategies used to curb inflation involves increasing the base rate. This is the rate the Bank of England charges other banks and lenders to borrow money. It increased multiple times over the last year - currently, the base rate stands at 5.25%.

When the base rate rises, this tends to influence mortgage lenders to increase their own interest rates. This can be good for savers because they’ll earn more interest on the money they hold in savings and current accounts. But for borrowers, it can lead to higher borrowing costs, making their debts more expensive including mortgage repayments.

Learn more: Struggling to remortgage due to affordability? Read our guide

Why does the Bank of England increase the base rate?

The Bank of England raises the base rate to try and stop consumers from spending and borrowing so much. This slowdown in consumer activity means companies can’t increase their prices so quickly, and should (in theory) reduce inflation. 

Base rate rises can affect both existing homeowners and potential buyers. If you already own your home and you have a variable rate mortgage, you may see your monthly payments increase. While for first-time buyers, they could find it harder to get a mortgage due to lenders’ affordability tests, which can be hard to pass when mortgages are less affordable. 

Homeowners wishing to move house or change mortgage deals can be affected too. If you were hoping to sell your home to buy a bigger property in the near future, the higher cost of borrowing may make you reluctant to take out a larger mortgage than you have now. While if you are coming to the end of a fixed rate term and want to remortgage onto a new deal, the current interest rates available may be unaffordable compared to your original rate.

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Does inflation affect fixed rate mortgages?

If you have a fixed rate mortgage, you won’t see a change in your monthly payments when the inflation rate rises until the end of your fixed term. When your fixed term expires, you’ll usually be moved onto your lender’s standard variable rate, which rises and falls based on changes in the market, or you can remortgage onto a new fixed rate deal.

In the months before your fixed rate expires, it’s a good idea to start looking for a new mortgage deal. Luckily, this is something we can help you with. Our smart tech will compare thousands of mortgage deals across the market in an instant to find which ones you’re eligible for. Create a free Tembo plan to get started. 

Should I fix my mortgage?

If you’re on a variable rate mortgage or your current fixed rate mortgage deal is coming to an end, we recommend looking at both fixed rate and variable deals to compare what’s available. During periods of market volatility, a fixed deal can protect you from fluctuations.

For example, in the 1990s and early 2000s when interest rates fluctuated between 3.5% and 14.88%, those lucky enough to fix at the lower end of the scale were offered a lot of protection. 

Equally, a variable rate mortgage can offer an opportunity to access lower interest rates and therefore lower monthly repayments. To understand whether a variable rate might suit you, calculate what your monthly repayments would be with the current market rates on variable mortgages. Add 1%, 2% and 3% to the interest rate and check the repayments. Does that seem comfortable for you? If not, the risk might not be worth the potential reward for you.

It’s always best to seek expert advice when it comes to deciding whether to fix your mortgage or not. If you feel overwhelmed looking at the different rates available, get in touch with our expert team.

Read more: How long should I fix my mortgage for?

What should I do if I can’t get a mortgage because of rising interest rates?

Are you struggling to pass lenders’ affordability checks and get a mortgage? Don’t feel disheartened. Here at Tembo, we are experts at helping people overcome this exact problem.

You may be surprised how often it happens and even more surprised at how easy it is to boost your affordability with the right help and support. 

If you’re finding it hard to get a standard mortgage, you may need to explore alternatives such as an equity loan, shared ownership scheme or Dynamic Ownership. If you have family, like a parent, grandparent or cool auntie who might be able to help, you may be better suited to a guarantor mortgage or family boost. 

An Income Boost, for example, lets you add a friend or family member’s income to the mortgage application to increase your borrowing potential so you can get a bigger mortgage. Rather than just taking your salary into account, the lender will include your Booster’s salary too. This type of mortgage is traditionally known as a joint borrower sole proprietor mortgage, but that’s a bit of a mouthful, so we gave it a makeover. 

If you’re struggling to save a big enough deposit but you have a home-owning family member who wants to help, a Deposit Boost can release equity from their property for you to use towards your deposit. 

These are just a snapshot of the buying schemes which our award-winning team can advise you on. If you’d like to learn more, start by creating a free Tembo plan. 

Our smart tech will check your eligibility for thousands of mortgage products from over 100 lenders to give you a personalised recommendation of how you could boost your budget. Then you can book in a 1-to-1 call with one of our expert mortgage advisors to walk through your options.

Discover how much you could boost your buying budget

We've helped thousands of buyers discover how they could boost what they could afford. In fact, on average our customers increase their buying budget by £82,000. To find out which buying schemes you could be eligible for and how much you could afford, create a free Tembo plan.

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