The City watchdog has said hundreds of thousands of mortgage borrowers are at risk of defaulting on their monthly payments, but which customers are most at risk and why?
Last week (January 11), the Treasury committee published a note from the Financial Conduct Authority which suggested “close to 200,000” households had fallen behind on payments by June last year, and a further 570,000 households are at risk of falling short on payments over the next two years.
FTAdviser asked brokers and property experts exactly which borrowers might be most at risk as fixed rate terms come to an end this year, with 1.4mn people set to refinance their homes.
I don’t think the outlook is as negative as the doomsayers believe. Yes there will be an affordability crunch, but I think it will be very unique niches of the market that are hurt.Dan Fatica, DJF Asset Management- One said those who bought new build flats five years ago with Help To Buy loans “will be the first to be hit”.
- Another said those on second charge mortgages could be in trouble, with lenders stressing future rates and reportedly “causing havoc with affordability”.
- A third said mortgages - particularly buy-to-let - in areas with high house values like the south east are “a time bomb”, with five-year terms set to renew from next year.
- While a fourth said it will come down to the type of income debt-laden households rely on, and how secure it is.
This month (January 2023), the average two-year fixed rate was 5.79 per cent according to MoneyFacts. A year earlier, it was 2.38 per cent.
The FCA’s figures, which totalled 770,000 borrowers in arrears or at risk of falling into arrears, are based on interest rates which factor in the September 23, the day the "mini" Budget was announced which sent interest rates soaring.
The regulator, having submitted the figures in mid-December, said they were “sensitive to changes in interest rates”. This could mean the number of borrowers at risk of defaulting on payments could now be higher or lower.
In September, the average two-year fixed rate was 4.24 per cent. In October, this figure climbed to 5.43 per cent. And in November, it peaked at 6.47 per cent. Since the, interest rates have been gradually trending down.
Inflation-linked HTB loans
Founder of DJF Asset Management, Dan Fatica, who specialises in short-term property finance, said the outlook is not as negative as “the doomsayers” say it is.
“Yes, there will be an affordability crunch, but I think it will be very unique niches of the market that are hurt,” Fatica continued.
“Those who bought new build flats five years ago with chunky Help To Buy loans will be the first to be hit.
“The interest rates on these mortgages are inflation linked. The scheme was always devised to prop up developers and construction sector first, occupiers were a delayed afterthought.”
Those with a Help To Buy government loan have to start paying interest in the sixth year of their loan term until they pay off the loan in full.
The interest rate starts at 1.75 per cent, but rises in April each year based on the rate of inflation at the time according to the consumer price index, plus 2 per cent.
Over the past year, inflation has peaked at 11 per cent, with it currently sitting at about 9 per cent.
This would mean for someone starting to pay interest this year, they will be paying more than double what they budgeted for when they initially took out the loan.
“For those that own a house with a mortgage who bought post-2008 but haven’t traded since, outstanding debt will be negligible versus the uplift they’ve experienced since,” said Fatica.
“But those who have borrowed for lifestyle purchases, large extensions to their own homes, might be feeling the pinch.”
Stressing second charge mortgages
One product borrowers tend to take out for lifestyle purchases is a second charge mortgage. These are secured loans on a property from a second lender - not the original lender.
“They're an alternative way to raise money, usually for home improvements or extensions of a property - they can be used for debt consolidation too,” managing director of PFEP Wealth Management, Richard Bishop, explained.
They can also be used to release equity by parents to help their kids onto the housing ladder.
Middle class borrowers tend to have more debt. We see families overreaching on credit cards to try and afford holidays.Oliver Laver, MortgageKey“The main reason is if the client has redemption penalties [early repayment charges] and they want to raise capital, so they use a second charge mortgage and then remortgage both loans into one at the end of the redemption term.”
The interest rate on these products tends to be around 2 or 3 per cent over the average mortgage rate, reflecting the additional risk.
MortgageKey founder and former City trader, Oliver Laver, told FTAdviser that when stressing a customers’ future mortgage affordability - for example, the customer is paying 1.3 per cent on their current mortgage and is fixed in for a further 12-24 months - the second charge mortgage lenders will stress the mortgage at 5 or 6 per cent.
“These new mortgage rates are causing havoc with affordability for new second charge mortgages,” Laver explained.
In the event of a customer struggling with their mortgage, Laver said lenders will likely treat every case individually.
“I know they would offer a payment holiday to begin with. Secondly, they would make a payment plan for the arrears and ask them to carry on paying,” he explained.
“So if the mortgage was £500 per month and they missed three monthly payments, so arrears total £1,500, they would perhaps ask for this over 12 months - which would be £125 per month plus the original £500 per month.”
Failing this, he said lenders would encourage the customer to sell the property and down-size or move into rental accommodation.
Over leveraged loans & high loan-to-value
While some lenders may recommend borrowers sell their property, this might not be the best option in the current market - one where house price growth has fallen for three months running and is set to correct itself by anywhere between 5 and 15 per cent.
“Where there becomes an issue is the people who are over leveraged and took out mortgages at 90 or 95 per cent loan-to-value,” Laver added.
“If they sell and property prices have decreased by 10 per cent, then they could potentially owe the bank.
“If the customer refused to sell, then the bank would legally be entitled to repossess which would of course be distressing.”
Laver would like to see a ban on repossessions like in the pandemic, and if a customer has a repayment mortgage he reckons an interest-only mortgage for a year could alleviate some pain in the short-term. The FCA has also recommended lenders use this product in the interim.
Founder of Edinburgh Mortgage, Mark Dyason, said buy-to-let mortgages, especially in the south east, are going to be a “time bomb”.
Terms on five-year fixes used to secure maximum loans at lower rates in areas where properties hold higher values will finish from next year onwards.
Some [buy-to-let mortgage holders] will find themselves underwater on the new payments and with house prices falling they are losing money in both directions.Mark Dyason, Edinburgh Mortgage“It’s house prices versus rental payments,” Dyason explained.
“If you max the loan then you’ve maxed your mortgage payments, ie, to nearer the rental than is needed elsewhere.
“Then rates go up. Some will find themselves underwater on the new payments and with house prices falling they are losing money in both directions.”
Sales manager at mortgage broker MB Associates, Phil Leivesley, agreed with Dyason.
“In the south east and any other high value areas, a lot of borrowers will have really stretched themselves,” he explained.
“Particularly when prices surged post-lockdown and borrowing was super cheap. It won’t take much of a change to these people’s circumstances, whether that be a reduction in income or an increase in outgoings, for them to be at risk.”
Middle class ‘struggle’
While many may not think of the ‘middle class’ as a vulnerable borrowing demographic, some brokers have pointed out how some families in this wealth category tend to overstretch themselves more than typically vulnerable customers.
Laver, who used to be a fixed income trader in the City, said middle class borrowers tend to have more debt.
There was a false sense of security that rates may never rise.Rachel Dixon“We see families overreaching on credit cards to try and afford holidays. They’ve got their utility bills in the background, and their mortgages which have gone from 1.5 to 6 per cent. All of a sudden, they’re struggling,” he explained.
Leamington Spa-based broker Rachel Dixon said she follows a page for mums on Facebook and that there are “numerous comments” asking for advice on the cost of living and help with mortgage payments.
“These normally are working families,” she said.
“Over the past 15 years, since the previous crash, we have been on fairly low interest rates. Anyone that’s had a mortgage in the past 10 years would never have seen these rates.
“There was a false sense of security that rates may never rise. People then took loans, cards and debts. Now the cost of living has spiralled and they can’t afford to repay it.”
But some brokers have been quick to point out that unlike other demographics, the middle class have far more lifelines to draw on in times of hardship.
“Yes the middle class do stretch themselves as it’s the ‘keeping up with the Jones’s’,” said mortgage sales head at London Mortgage Partners, David Gissing.
“But they typically can pull strings, family, as well as more savings and investments to get by.
“Lower income households and those who are working class don’t have those luxuries or such access to support.”
Harmony Financial Services director, Imran Hussain, also said mortgage interest rate rises will impact everyone - both the middle class and working class.
“Casual workers, those who work through agencies or on shorter-term and flexible employment terms - they’re going to be in trouble if they are laid off,” Hussain explained.
“Families with two workers, or someone with two different revenue streams, are going to be fine,” he said, recalling a conversation with a client who is both a nurse and a make-up artist.
“One industry might slow while the other is busy. But households reliant on one income, they will always be financially stretched.”
ruby.hinchliffe@ft.com
