Could higher rates still deliver a mortgage crisis?

view original post

Since mortgage rates began rising, many of the nine million mortgaged households in the UK and close to two million landlords have been faced with the prospect of much higher payments.

Many had become accustomed to ultra-low interest rates for more than a decade.

In this six-part series, we look at how much more people are really paying when they take out a new mortgage, how households are coping and if a mortgage crisis is afoot.

Crisis point? For households with a mortgage, this will typically be by far the largest part of their overall monthly spending

Previously, we looked at how much more people are paying for new mortgages compared to the cheaper deals many are rolling off.

We also revealed  the extent to which people are raiding their savings, falling behind on their mortgage payments and having their homes repossessed and why so many households are coping so well under the strain of higher rates.

We spoke to a number of mortgage brokers to hear first hand how their customers are being impacted and looked at the wider implications for buy-to-let landlords.

Here we look at whether a mortgage crisis could still unfold over the coming months and years.

Have lockdown savings protected borrowers?

It’s hard to imagine that after a cost of living crisis that saw double-digit inflation erode everyone’s spending power, that people may be in a better position to cope with higher mortgage rates now than they were in the past.

The pandemic ignited something of a savings boom, as the constraints of lockdown and impetus of economic uncertainty resulted in many people spending less and saving more.

In the 12 months prior to the pandemic, the total savings deposited by Britons rose £70 billion from £1.43 trillion to £1.5 trillion, according to Bank of England figures.

In the 12 months after the first lockdown began, from 31 March 2020 to 31 March 2021, the amount saved rose by £180 billion from £1.5 trillion to £1.68 trillion.

This represents more than a 150 per cent savings increase during the first 12 months of the pandemic, when compared to the previous year.

And while savings boomed, the UK also saw higher wage growth than in previous years.

In the four years between February 2020 and February 2024 average regular pay (excluding bonuses) rose by 24 per cent, according to the ONS. That’s slightly higher than the 22 per cent consumer prices index inflation over the same period.

Savings boom: Many Britons squirreled away a lot of cash during the pandemic which may be why we are seeing more people able to cope with higher mortgage costs

Of course, each household’s situation will be different. There will be some that were not able to build up their savings during the pandemic and others that will have not seen their incomes rise.

For those who did not benefit from the pandemic savings rush or wage price spiral, the higher costs of goods or services will be more painful. 

People are also typically reluctant to dip into their savings to cover highly monthly bills and so even those who did build up a lockdown pot, will feel poorer.

‘Borrower circumstances may have changed and given a stronger platform to weather the storm,’ says David Hollingworth, associate director at L&C Mortgages.

‘Certainly households tended to build up savings reserves in the pandemic, so some may be having to call on those reserves to help deal with the current situation.

‘That could allow the mortgage to be reduced when they come to the end of the current deal for example.’

Chris Sykes, associate director of mortgage broker Private Finance, says fiscal drag from taxation means average wage increases won’t be quite as good as they sound

Tax freezes eat into pay rises 

It’s important to also remember that many personal tax thresholds have been frozen in cash terms since April 2021, whereas previously most were due to rise in line with CPI inflation.

This has dragged more people into higher tax bands, for example, the number of workers paying 40 per cent tax on some of their income has increased substantially.

Meanwhile, the 45 per cent tax threshold has been lowered from £150,000 to £125,140.

The 60 per cent marginal rate tax trap for those who have their personal allowance removed above £100,000 has also not budged.

All of this so-called fiscal drag pulls more people’s pay rises into higher tax bands. 

As Chris Sykes, mortgage technical manager at Private Finance, puts it: ‘Alongside the cost of living, wage increases are taxable, if you get a 5 per cent raise you might well be paying tax on that 5 per cent so leaving with net may be 3.5 per cent if you’re a higher rate taxpayer.’

How much more could people face paying on mortgages? 

Many people coming to the end of their five-year, three-year, or two-year fixed rate mortgage today will be on a rate of 2 per cent or less.

The average five-year fix is currently 5.5 per cent, according to Moneyfacts, while the average two-year fix is 5.93 per cent.

The average amount being held by borrowers on a fixed rate mortgage is currently £164,000, according to UK Finance data.

A £164,000 mortgage on a 2 per cent rate with 20 years left to run would cost £830 a month.

But on a 5.5 per cent rate over the same repayment timespan the monthly costs rise by £298 per month to £1,128 a month.

If a homeowner has 40 per cent equity in their home, they might be able to secure a lower five-year rate of around 4.5 per cent, or around 4.8 per cent if fixing for two years. 

Switching a £164,000 mortgage to a 4.5 per cent rate on a 20 year term would see someone paying £1,038 a month.

The impact is much greater for those with big mortgages. A borrower with a £400,000 mortgage outstanding and 20 years left to run shifting from a five-year fix at 2 per cent to a five year fix at 4.5 per cent, would see monthly payments jump from £2,023 to £2,530.

This is a £507 monthly jump, equating to £6,084 per year, which is £10,000 before tax for a higher rate taxpayer. 

This is Money’s mortgage calculator below, allows you to see how much higher rates will cost people with different sized mortgages. 

Compare true mortgage costs

Work out mortgage costs and check what the real best deal taking into account rates and fees. You can either use one part to work out a single mortgage costs, or both to compare loans

Incomes are unlikely to match mortgage rises 

Some of the sting will have been taken out of a jump in mortgage costs by rising wages, but as we explained above tax has eaten into the benefits. Meanwhile, the cost of living crunch has sent other bills up to, from energy and broadband, to food and discretionary spending.

Peter Stimson, head of product at Mpowered Mortgages, thinks rising incomes by and large won’t have gone up enough to meet the higher mortgage costs.

He says: ‘Those re-financing might have seen their mortgage payments increase by one-third.

‘In addition to their current mortgage, many customers also took out cheap finance deals prior to the interest rate raises, particularly for consumer items such as cars, which need to be factored into affordability tests.

‘Higher salaries can help with the affordability challenge, but given that mortgage affordability has been reduced by around a whopping 30 per cent since 2022, this doesn’t always help enough.’

Could the mortgage crunch still turn into a crisis?

It’s looking unlikely that current interest rates will be enough to cause a full blown crisis, as long as employment remains strong and the relatively tight jobs market supports wages.

Although mortgage arrears rose slightly by 3 per cent in the first three months of this year compared to the previous three months, according to UK Finance data, we remain a long way off the levels seen during the 2008 financial crisis.

Arrears and repossessions?

Mortgage arrears are when people fall behind on their mortgage repayments. 

A repossession is when a lender takes control of a property after a borrower has defaulted on their mortgage, in order to sell it. This is a last resort after other options have been explored.

In 2009, mortgage arrears were roughly double what it is now. Repossession numbers also remain very low compared to historic norms, according to UK Finance

That said mortgage rates have been back on the rise since the start of February after undergoing six months of successive cuts.

At the start of the year the lowest five-year fixes were below 4 per cent. Now they are hovering around 4.5 per cent. 

The lowest two-year fixes were just above 4 per cent in January. Now they are hovering closer to 5 per cent.

Even slightly higher rates add to the overall squeeze facing households and could push up  arrears.

Interest rates and the economy

This upward trajectory for mortgage costs has a lot to do with what markets and investors forecast for interest rates

At the start of the year, markets were forecasting there to be six or seven base rate cuts by Christmas, but they have since rolled back on this to just two.

Ultimately, what the future holds for interest rates will greatly depend on the rate of inflation.

But it will also hinge on the outlook of the UK economy alongside wage growth and unemployment. 

At the moment the economy appears to be holding up with economic growth faster than expected. 

UK GDP (gross domestic product) grew 0.4 per cent in March, following a 0.2 per cent rise in February, with growth in the first quarter of 0.6 per cent. As a result Britain officially exited recession

Nicholas Hyett, investment manager at Wealth Club said: ‘The Bank of England will be particularly pleased with itself looking at these numbers. 

‘With the economy looking healthy, a rate cut in May would be looking premature now.’

Expectations are now that rates will be cut in June but the Bank could hold firm, fearing that a cut now could spell a rise in future if inflation picks up again and the economy runs hotter than previously thought. 

Pete Mugleston, managing director and mortgage expert at Online Mortgage Advisor, says: ‘Economic growth could also prompt the Bank of England to maintain or even raise the base interest rate to prevent inflation, which would result in higher borrowing costs for mortgage seekers.

Base rate history: The highs and lows of how interest rates have moved since 1973

The Bank of England could also be swayed by the interest rate decisions made by other central banks, such as the Fed and the European Central Bank (ECB) in order to keep the pound competitive.

The chair of the US central bank, the Fed, has suggested that interest rates may need to stay higher for longer, while conceding at least that the next move won’t be to increase the rate. 

That’s in contrast to the Bank of England Governor, Andrew Bailey hinting that Britain could cut interest rates before the US.

Bailey said that progress in the battle against inflation may mean it needs to cut rates by more than markets currently expect.

He said: ‘There is no law which says that the Fed must move first and everyone else including us moves afterwards.

‘With the progress we’ve made… it is likely that we’ll need to cut the Bank rate in the coming quarters, possibly more so than is currently priced into markets.’ 

However, even if cuts do arrive, base rate could only fall so much over the coming months and years – perhaps sticking at around 4 per cent or higher.

During the last financial crisis, the Bank of England cut base rate from 5.75 per cent in July 2007 to 0.5 per cent in March 2009 – the lowest point in more than 300 years of bank rate history.

It did this to support the economy at the time. There is an argument that the Monetary Policy Committee will prefer to keep rates higher to ensure it has this agrressive rate cutting tool in its arsenal were another crisis to unfold.

Lowest mortgage rates vs base rate: Between 2008 and 2022 the Bank of England base rate has always been higher than the lowest fixed rate mortgage

Could a wave of unemployment change everything? 

If rates are unlikely to cause a crisis, a large uptick in unemployment might do, with people suddenly out of a job and unable to pay their mortgage. This was the driving force behind the early 1990s recession and mortgage crisis, along with the preponderence of variable rate mortgages.

An unemployment spike would have the potential to kickstart an arrears and repossession crisis. But again the figures are holding up to date.

While the unemployment rate saw another slight uptick to 4.2 per cent in the three months to Jan, according to the ONS, it remains low from a historical standpoint, well below the 7.54 per cent recorded in 2009 in the aftermath of the financial crisis.

Paul Dales, chief economist at Capital Economics said: ‘The main message is that without a big rise in unemployment, there is unlikely to be a worrying rise in mortgage defaults. 

‘The risk of a big rise in unemployment appears to be fading now that the recession appears to have ended and as the recession was so short and small. 

‘To get a big rise in unemployment you would need something new to trigger a big economic downturn or a recession. 

‘That’s unlikely to be higher interest rates or much tighter fiscal policy than currently planned, so it may need to be some overseas shock or something breaking in the UK or global financial system.’

In UK finance’s latest household review, Lee Hopley, director of economic insight and research said: ‘In this cycle, with unemployment set to remain low and extensive lender forbearance helping the vast majority of customers in arrears to recover their position, we expect possessions to remain very low by historic comparisons. 

‘For the small minority who are unable to do so, this will not feed through into possession numbers until next year.

‘We expect pressure on mortgage payments to continue through this year. But, with a benign employment picture and extensive, tailored forbearance, the industry will be able to help the vast majority of struggling customers to get back on track, keeping possessions to an absolute minimum.’