The result of rising interest rates is that there is an increase in mortgage payments resulting in a lower demand for housing. On the other hand, a fall in interest rates should fuel higher market demand and put increasing strain on house prices. This is supposed to enhance expenditure connected with house-buying and the rise in prices will add to total housing wealth and make consumers more positive about their personal finances.
The cut in interest rates from 7.5% in October 1998 to 5% in June 1999 was said to be a major factor in the acceleration in housing market activity during the summer of 1999. Equally the series of increases in interest rates from 5% in June 1999 to 6% by February 2000 helped to take some of the excess demand for housing out of the market and contributed to a slowdown in the rate of house price inflation during the summer of 2000.
Effective disposable incomes of mortgage payers
If interest rates fall, the effective disposable income of home-owners who have variable-rate mortgages with their building society or bank will increase – leading to a rise in their purchasing power. Home-buyers with fixed-rate loans will not be affected much in the short term. Lower mortgage rates should stimulate an increase in new mortgage approvals and normally cause a growth in housing market activity.
A lower interest rate persuades people to spend using a variety of forms of credit and should improve demand for larger purchases.
When interest rates fall, there is a re-distribution of income away from lenders (who receive less) towards those with variable rate loans. People with positive net savings also stand to lose out from big cuts in interest rates.
Commonly changes in interest rates have an effect on consumer confidence. Only when people are plausibly confident about their own financial position are they willing and able to enter into large scale purchases. Higher interest rates have a negative effect on consumer confidence - lower rates have the reverse effect, although again there are time lags to consider.
James Hunt has spent 15 years as a professional writer and researcher covering stories that cover a whole spectrum of interest.
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