A gloomy outlook has been forecast for a significant minority of borrowers over the next four years. A report, Mortgaged Future – Modelling household debt, affordability and access to re-financing as interest rates rise, published by the Resolution Foundation, suggests that modest rises in interest rates could cause significant affordability pressures for some 2.3m mortgaged households. It says that the figures are designed to be indicative of the potential scale of repayment problems that could follow as interest rates rise.
It identifies two groups who could be badly affected: highly geared mortgage borrowers – those who spend more than a third of their after-tax income on mortgage repayments – and those unable to access credit in the way they did before the crisis. This second category includes those with very low levels of equity in property – with mortgages equivalent to 95 per cent or more of their current property value – and with higher levels of equity, but non-standard circumstances, such as interest-only or self-employed borrowers. Table 1 shows the number of those likely to be affected.
The Foundation has based its projections on OBR forecasts, which suggest any recovery in pay is likely to be gradual at best and wages are likely to remain flat until 2018 compared to RPIJ inflation. There are also austerity cuts that will lead to reduced benefits and tax credits, reinforcing the poor prospects for increased income. The conclusions have been reached based on current levels of affordability and expectations that Bank base rate will rise to 2.9 per cent by the end of 2018.
Affordability problems
It found the proportion of households reporting difficulty in paying mortgages rose from 14 per cent just before the crisis to a high of 19 per cent in 2011. Yet this is despite the fall in mortgage costs enjoyed by many from 2011 onwards. The number of households experiencing affordability problems has remained relatively stable since. It says, compared with the problems in the 1990s, the figures are lower. However, when base rate levels are taken into consideration it suggests the number of struggling households appears “highly elevated”.
This is alarming because the lower cost of mortgages has provided an opportunity for borrowers to reduce debt. Many, however, have been unable to take advantage of the climate due to unemployment, underemployment and falling incomes.
While improvements on several economic fronts – productivity and employment, for example – are to be welcomed, they increase the pressure on the Bank to “bring an end to the mortgage party via monetary tightening”.
The Bank has made it clear that as far as possible, rate rises, when they come, will be gradual. However, where borrowers have been unable to remortgage, they remain on some form of variable rate, leaving them vulnerable to any rate rises. Coupled with the poor outlook for incomes and debt, even modest rises could spark “significant affordability pressures”.
Crisis delayed?
In light of so many households apparently facing difficulty meeting mortgage costs in this relatively favourable environment the Resolution Foundation asks whether the mortgage repayment crisis has simply been delayed rather than averted?
So how can what is effectively a slow motion car crash waiting to happen be avoided? The Resolution Foundation suggests three courses of action for the government, lenders and borrowers:
• Maintain low interest rates until there is clear evidence of sustainable, broad-based recovery in household incomes;
• Be proactive in ensuring that households make appropriate re-financing decisions and lock in low rates; and
• Support those households in debt crisis, with debt advisers and review mechanisms for minimising the upheaval associated with exiting the housing market.
The CML appears rather dismissive of the report’s doom-laden projections, suggesting lenders can sidestep the new affordability rules via arrangements made for “mortgage prisoners” under the Mortgage Market Review. Provided there is no increase in borrowing, lenders should be able to move them on to more suitable mortgage deals. All this has yet to be tested and there is likely to be a variety of responses from lenders to borrowers.
Ultimately, the picture the report paints is not inevitable. It says “We make no attempt to predict or forecast the future. Instead, we simply set out what would happen if the specific conditions we assume were to hold.”
Nevertheless, as the CML warns, “higher interest rates are coming sooner or later – the questions are when, not if, and how borrowers are going to cope with higher borrowing costs?” We can’t say we haven’t been warned.
