A fall in house prices could lead to higher mortgage rates for 350,000 mortgagors, according to a recent blog from Bank Underground.
Written by Foreign, Commonwealth and Development Office deputy chief economist, Fergus Cumming, and Bank of England private secretary and chief of staff, Chris Walker, it cautioned that house price falls could push borrowers into more expensive LTV bands.
The blog, which is for Bank of England staff, explained that, in a scenario where house prices fall by 10 per cent and high LTV spreads rise by 100 basis points, an additional 350,000 mortgagors could be pushed above an LTV of 75 per cent.
This could, in turn, increase their annual repayments by an extra £2,000 on average which could have a “material impact” on the economy.
Explanation
It explained that, loosely speaking, a mortgage interest rate is made up of the risk-free rate, and some compensation for risk, known as the spread, and that LTV ratios are the key determinant of spreads.
As an example, Cumming and Walker stated that someone with a deposit of 25 per cent of the value of the house at the point the mortgage is issued qualifies for a 75 per cent LTV mortgage.
This would come with a lower interest rate than if they only had a deposit worth 10 per cent of the value.
“Mortgages with higher deposits, and therefore lower LTVs, are generally safer for banks because higher deposits means borrowers can withstand larger house prices before falling into negative equity,” they explained.
“Higher LTV mortgages tend to have interest rates for that reason.”
Additionally, Walker and Cumming explained that, throughout the 2010s, it was common for the spread between 90 and 75 per cent LTV mortgage rates to be between 1 and 2 percentage points.
However, that has changed recently because, as of August 2023, that spread was less than 0.4 percentage points.
Spreads have been very narrow since 2021 and the last time spreads were at today’s levels was probably in 2008, which is before the official data began.
Given that high LTV mortgages look relatively cheap compared with recent history, the blog constructed an “illustrative” scenario where the 90 per cent LTV spread returns to close to its post-2010 average.
This scenario was constructed as Walker and Cumming described it as “plausible”.
The scenario
In the scenario analysis, Walker and Cumming explained that the 90 per cent LTV mortgage rate increases by 100 basis points and house prices fall by 10 per cent.
It further detailed that, at origination, around 40 per cent of recent mortgages had deposits that were too small to be eligible for a 0-60 per cent or 60-75 per cent LTV mortgage.
When the blog took account of principal repayments and house price growth since origination, that suggests around a quarter of recent mortgages - just under 800,000 - are above that 75 per cent LTV threshold.
It found that house price fall in the scenario pushes an additional 350,000 mortgagors above the 75 per cent LTV threshold, taking the total back to around 40 per cent of recent mortgagors, or 1.1mn.
It also pushes around 3 per cent into negative equity.
Therefore, the assumed 100 basis point increase in mortgage spreads in the scenario leads to an average increase in annual repayments for these mortgagors of just over £2,000 by the time they refinance, over and above the impact from the increase in swap-rates.
tom.dunstan@ft.com
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