The study suggests that around 770,000 households fall into both of two potentially problematic categories of mortgage borrowers:
Those already at risk of being “mortgage prisoners” because of their limited ability to switch to better deals in order to insulate themselves against future rate rises
Those facing the likelihood of becoming “highly-geared” – with their monthly mortgage repayments eating up at least one-third of their disposable income by 2018 as interest rates rise
This most vulnerable group is therefore doubly exposed. They are likely to be restricted in their ability to renegotiate their borrowing - either because they have very low equity in their home (less than 5 per cent) or because they are self-employed or have interest-only mortgages, categories which make borrowers less attractive to mortgage providers. At the same time, the level of their outstanding debt means that even the relatively modest rise in interest rates expected by 2018 will push them into the highly-geared category.
Instead of switching to more competitive deals (often on fixed-rates), this most vulnerable group will often have little option but to repay at their lender’s standard variable rate, leaving them fully exposed to changes in the Bank’s base rate - which is expected to climb to almost 3 per cent by 2018, from the current rock-bottom level of 0.5 per cent where it has been for five years.
The report emphasises that not all those with very low equity, who are self-employed or who have interest only mortgages will be in this most vulnerable group – it only comprises a smaller sub-section of borrowers who both fall into one of these categories and whose repayments will be more than one third of disposable income by 2018.
A much larger group – 2.3 million households or more than a quarter of the UK’s 8.4 million mortgagors –face potentially unaffordable repayments by 2018 based on current market expectations for interest rates. This is more than double the number of households in this position today (1.1 million). But in anticipation of rate rises, many of those facing potential affordability problems down the road will seek to refinance to improve their circumstances and secure some certainty over future payments.
Similarly, the overall population of those potentially at risk of being a “mortgage prisoner” is estimated by the Resolution Foundation to be around 3.5 million borrowers. But some of these will be able to successfully negotiate new terms - such as those who are self-employed on high or stable incomes, or those on an interest only deals who can afford to switch onto a repayment mortgage - and in most cases they will be able to bear the extra cost of rising interest rates.
The Resolution Foundation’s new research is the first attempt to identify the smaller subset of most vulnerable borrowers who are likely to face affordability problems down the road when rates rise, and who are also at risk of being constrained in their ability to act now in the market to improve their position.
The study provides stark evidence of the implications of the drawing to an end of a golden age for many mortgage borrowers as well as the legacy of easy credit that existed in the years running up to the crash. Speaking at the weekend, Bank of England governor Mark Carney expressed concern about the recent rise in house prices resulting in a possible resurgence of high loan-to-value mortgages which could increase our “debt overhang” and result in economic instability.
With interest rates at ultra-low levels since 2009, millions have been able to pay down their mortgages at unprecedentedly low monthly rates. A household on tracker mortgages with a £75,000 mortgage over this six-year period has netted a cumulative gain of around £12,400, compared to the cost of meeting the same mortgage before 2008, with households with larger mortgages benefitting by far more. This big mortgage windfall for many home-owners co-incided with a period of unprecedented falls in real wages and household incomes. Many households also failed to gain from the full reduction in interest rates and, as a result of these factors, the proportion of those with mortgages who reported they are struggling to make repayments only fell slightly during this period of rock-bottom interest rates.
The expected rise in interest rates, which most analysts think will start in early 2015, will increase monthly repayments at the same time as the Mortgage Market Review introduced by the Financial Conduct Authority means that lenders are setting far more stringent conditions on borrowing. While the review allows lenders more latitude in arranging new terms with existing borrowers it is not clear if lenders will take advantage of these provisions.
Among the Resolution Foundation report’s other findings are:
The current affordability problem is greatest among the lowest-income households: 25 per cent of those spending more than a third of their income on mortgage repayments are in the bottom tenth of the income distribution
As interest rates rise, the affordability problem is set to spread up the income distribution. By 2018 only 15 per cent of those spending a third of income on repayments are expected to be in the lowest tenth by income
The East of England and London are most exposed to the affordability risk. Here 35 per cent of mortgagors are found to be highly-geared in 2018, compared to only 18 per cent in Scotland and 19 per cent in Yorkshire and Humber
Northern Ireland and London are the parts of the UK where borrowers are most likely to be in the most vulnerable group – with 16 per cent and 13 per cent of mortgagors respectively projected to be both highly-geared in 2018 and at risk of being mortgage prisoners today
Northern Ireland is also the region where low equity is most common – 35 per cent of mortgagors have less than 5 per cent equity in their home, compared to just 2 per cent in London
Matthew Whittaker, chief economist at the Resolution Foundation and author of the report, observed that many borrowers have enjoyed spectacular savings over recent years, with mortgage rates falling to historic lows, and most will be able to ride the tide of gradually rising interest rates. But for around one-in-four, even modest rate rises could create financial difficulties.
"Those at greatest risk are members of this group who also find themselves unable to access the best deals in the market today. Almost one in 10 households are doubly exposed: facing the prospect of their mortgage becoming increasingly unaffordable in the future and with the market offering them limited, if any, choice today.
There is still a window of opportunity to think creatively about the best way of reducing the risk to this vulnerable group while we still have ultra-low interest rates. But that era is coming to an end relatively soon and the legacy of easy credit and the associated debt-overhang still has to be reckoned with. Financial institutions and policy-makers must consider now how best to minimise the scale of the adjustment problems these families face when interest rates start to return to normal.”
Mortgaged Future by Matthew Whittaker is published online by the Resolution Foundation on Tuesday 20 May. Modelling for the study draws on data about household finances from the Family Resources Survey and combines it with financial outturns and projections published by the Office for Budget Responsibility.
This study is part of a year-long project conducted by the Resolution Foundation to investigate the UK’s high level of household debt and how to manage it when interest rates start to return to normal. The project’s final report will be published in June.
