Why inflation is making housing more affordable

Everyone making predictions on how the property market is going to move are forgetting one important fact.

Halifax reports that mortgage affordability is at a 12-year high due to record low mortgage interest rates. The bank also says that buying now costs an average £100pm less than renting – including lost savings interest from the deposit, and repair and maintenance costs.

On top of that, Nationwide has just announced that house prices have just got cheaper, i.e. more affordable. Its latest house-price index shows that house prices fell in August, so house prices are now 0.4% lower than a year ago.

Meanwhile, the Land Registry puts prices in England and Wales at 2.1% down over the year to the end of July, and Hometrack reckons prices in the UK have fallen 3.7%:

Estimates of average house price changes

House prices still appear high

And yet house prices still appear high when you consider that they have gone up far faster than inflation as a whole over the past 60 years, and that house prices are higher compared to salaries.

This is mitigated a fair bit by the fact that we have many more dual-income households today. It's also softened by the fact that National Statistics' relatively new way of estimating income makes house prices seem far higher compared to salaries than in the past (a change that many commentators appear not to have noticed).

Yet even taking these things into account, many would say that house prices are still overpriced.

There are two ways to a correction

Yet, if we assume for this article that house prices are definitely over-priced, that still doesn't mean they have to fall hard and for a sustained period. You see, there are two ways to get a property-market correction.

Take a look at the fourth column of my table above. Some price correction has happened in the past four years, with prices falling between 8% and 18% on average. But what you might not realise is that there has been an equal correction in the opposite direction – through inflation.

We have had a lot of inflation in the past four years, which has increased the average price of the things we buy by about 14%. And, currently, prices are rising at a rapid 5% per year. Almost everything is going up in price.

Inflation pushes up salaries, which makes paying for property at current prices more affordable.

This means that, each month that goes by, house prices become more realistic through general price inflation. This increases the natural price of property, it makes prices less likely to crash, less likely to crash as far, and less likely to stay down for long if they do.

To add to that, governments have always been keen on encouraging inflation to get out of their debt problems, and the Bank of England definitely seems to have been on the government's side with this. The Bank's newly knighted governor and his team have kept interest rates low for years, even though raising rates is the usual means of combating high inflation. To the same end it has pumped hundreds of billions of pounds into the system too.

The key cause of a crash?

I think most people argue that the catalyst to a future crash will be rising interest rates. However, rates are increased to combat higher inflation. This means that while interest payments rise, they are doing so at a time that inflation is making the mortgage debt itself easier to pay off in real terms.

That's why rising interest rates haven't historically coincided very well with falling prices, as I wrote in The greatest threat to mortgage holders.

How to make it go swimmingly

There will be different winners and losers depending on how the market corrects. But those of you looking at worryingly large mortgages can massively reduce your risks – and therefore boost your chances of being a winner – by locking in a cheap long-term fix at today's excellent prices. That will prevent rising interest rates being a problem, while inflation will erode the difficulty of paying off your big debt.

As I wrote at the beginning, Halifax estimated mortgages are at their most affordable in a dozen years. This is because the current average interest rate is a very cheap 3.85%. However, for 3.99% – just slightly more – you can fix for ten whole years. In other words, you can lock in those affordable rates for many years to come.

All sorts of things affect the property market. With the economy on edge and more than a quarter of mortgage holders having less than 10% equity in their homes (and 800,000 of them already being in negative equity) versus high inflation, I think it's going to be a close call whether the market makes serious and sustained falls before inflation can give property prices the support needed to sustain them.

More: compare mortgages through lovemoney.com | Fix your mortgage at 3.99% for ten years | The hidden costs lurking in your mortgage