An analysis from DBRS Morningstar found that static incomes and short-term teaser rates left borrowers exposed to increases.
It said as the most popular mortgage product was a two-year fixed rate, borrowers would either be affected by rises immediately if they were on variable rates or in the near future when it came to refinancing.
The analysis revealed that 80 per cent of the outstanding UK mortgage book is on a fixed rate. Of this, 97.2 per cent have a remaining period up to five years while only 2.7 per cent have a fixed rate period between five and 10 years.
DBRS Morningstar analysed a sample of UK mortgage portfolios to assess what impact rising energy costs, interest rates, and the general increase in the cost of living may have on mortgage borrowers. This consisted of 543,000 loans across 57 UK mortgage portfolios.
Borrowers by income band
DBRS Morningstar said the consequences of the cost of living crisis would vary depending on borrower income and personal circumstances.
Using Office for National Statistics (ONS) data for the period April 2019 to March 2020 to determine household income thresholds, it found that an income of less than £987 a month would put a household in the bottom decile or 10 per cent while an income of £7,503 a month would be in the top decile.
For simplicity, DBRS Morningstar assumed the income of mortgage borrowers remained unchanged since obtaining a mortgage.
It found that fewer mortgage borrowers were towards the bottom of the income range, with just three per cent falling in the lowest decile and 16 per cent of borrowers in the bottom three income tiers with incomes of less than £2,000 a month.
This was compared to 30 per cent of the general population who fell in these income tiers.
Mortgage holders were found to be over-represented in mid to high income deciles, with monthly incomes between £2,000 and £7,000.
Fewer borrowers were also in the top decile with incomes above £7,000 a month compared to the general population. The firm said households who have lower incomes were more likely to be renting while very rich households were able to either buy without a mortgage or become mortgage-free more quickly.
Less disposable income for all mortgage borrowers
Alongside this, the firm used ONS data to look at average household expenditure by income segment across the same period.
It assumed a 54 per cent increase in energy bills, 10 per cent rise in transport costs, a five per cent uptick in other expenses and a 0.25 per cent hike in mortgage interest rates. However, it noted that the majority of borrowers would not be immediately affected by changing mortgage rates.
DRBS Morningstar also assumed a one-time council tax rebate of £150 for the bottom seven income bands – deducing that borrowers on lower incomes would likely qualify due to property type – and factored in the £200 ‘buy now pay later’ credit on energy bills this year.
It found the impact of such initiatives was most prominent on those in the lowest income brackets.
The analysis showed that monthly expenditure would increase for each income group, with those on lower incomes seeing a £57 rise per month and higher income households seeing a £116 monthly increase. This averaged at £90 more in expenses each month for all mortgage borrowers.
This would reduce disposable income, DBRS Morningstar said, leaving lower income groups with a larger percentage drop in remaining funds.
For those in the bottom decile and assuming there is no growth in income, this would represent a 110 per cent reduction from having £93 left over after essential expenses to living beyond their means by £10 each month. For those in the highest income decile, this would result in a 10 per cent drop in disposable income.
On average, this would be a 36 per cent reduction in disposable income for all mortgage borrowers.
However, DBRS Morningstar said mortgage borrowers would prioritise repaying their loan and reduce discretionary spending such as socialising. As a result, mortgage performance will remain stable in the immediate future.
Additionally, although economists expect rising inflation to be temporary, the firm added: “If inflation proves more persistent over the next few years and income growth remains muted, the situation may get more serious with some borrowers facing issues with debt servicing.”
DBRS Morningstar said it would monitor the situation and potentially run further analysis on mortgage portfolios to see what impact the prolonged period of inflation coupled with low wage growth has on affordability.
Mudasar Chaudhry, head of European structured finance research at DBRS Morningstar, said: “Due to the rising cost of living with limited real wage growth, personal finances have been stretched more than ever in past two decades, especially in the UK, which has experienced higher energy and fuel costs, higher debt financing costs, and increases in some taxes – for example National Insurance.”
