In its Trends in the Economy And Lending (TEAL) report, UK Finance said there were 1.3 million borrowers on fixed rate deals set to end this year.
Taking into account that many of those borrowers would be able to fix to another deal, the combined pressures from cost of living and refinancing would still result in a typical reduction in free income of around seven per cent.
UK Finance also found that, on average, the combined impact of inflation, income and tax changes would knock around three per cent off of borrowers’ “wiggle room”.
Wiggle room is defined by UK Finance as the proportion of net income left after subtracting initial mortgage payments, basic household expenditure and credit commitments.
Wiggle room is also used in the income-affordability test undertaken by mortgage lenders as part of the FCA’s responsible lending rules, although it excludes any interest rate stress test.
James Tatch, principal, analytics at UK Finance, said that three quarters of mortgage customers, including almost all recent borrowers, are on fixed rates and so will see no increase in payments in response to bank rate increases through 2022.
But he warned that of those who were coming off fixed rates this year, there “would likely be some at the margins, and particularly among lower-income brackets, who would no longer pass the same affordability test as they did last year”.
“Overall CPI inflation hit 9.1 per cent in May, driven by the persistent supply chain issues that began with Covid-19, and the global economic fallout of the ongoing crisis in Ukraine. The Bank of England now predicts inflation will peak this year at over 10 per cent. Responding to escalating CPI, the Bank has raised rates four times in the first six months of 2022.”
Tatch said: “While this is not unprecedented – RPI was over 12 per cent in 1981, and almost 25 per cent in 1974 – two generations of current mortgage customers were not yet born at the time and have had no experience of a UK in which inflation was a cause for widespread national or personal concern.”
Tatch said the issue for households in 2022 was that wage growth was not expected to keep up with price growth in the way it during the two previous periods of high inflation. “While this avoids an economy-wide wage-price spiral, it also means that households are set to see a significant contraction in real incomes.”
Most will have wiggle room
UK Finance said most of those coming off a fixed rate would be able to afford a three per cent average decrease in their wiggle room by absorbing these increased costs and still afford their mortgage.
This is helped by the fact that “virtually all new mortgages are currently fixed rate deals, and over half of these are fixed for five years or more. This means that those recent borrowers will not see increases in their mortgage payments as other costs rise through this year”.
Five and two-year fixed rate deals maturing this year account for around two thirds of those fixed rates maturing in 2022.
For 2017 originations, those coming off five-year fixed deals, the typical cost-of-living impact is broadly neutral. This is because income growth over the period since borrowing has cancelled out cumulative price growth. UK Finance added that there would still be a decrease from refinancing costs of around 4.3. per cent, leaving the average borrower with around 28 per cent of their net income in wiggle room.
For 2020 originations, the decreases in wiggle room are greater, with a 2.6 per cent fall due to cost-of-living effects and seven per cent from refinancing. However, borrowers in 2020 had, on average, significantly greater wiggle room at origination compared with the 2017 cohort, meaning that their typical position after refinancing in 2022 is broadly the same at 28 per cent.
UK Finance said although the typical borrower would still have over a quarter of their disposable income left over, its analysis shows that these effects are not evenly distributed and some, including those in lower-income brackets, would see a proportionately greater decrease.
“We can see that those at the lower end of the income scale are the most impacted, seeing a 10 per cent overall reduction in their wiggle room to around 18 per cent on average.”
“Our modelling suggests around nine per cent of all borrowers with maturing fixed rate deals this year would be left with less than 10 per cent wiggle room after refinancing, and a further 20 per cent would have between 10 and 20 per cent wiggle room.”
One difference between 2022 and the two earlier comparative periods was the availability of longer-term fixed rate deals at similar or lower rates than shorter-term products.
Longer term availability
The report stated: “According to Moneyfacts, at the time of writing the average 10-year fixed rate for a customer with a 75 per cent loan to value was 3.64 per cent, compared to 3.78 for a two-year fix and 3.85 for a five-year fix. So, customers looking to fix what is usually their largest monthly outgoing for longer, through this period of rising wider cost pressures, are able to do so at negligible additional cost, or may even be able to save money by doing so.”
UK Finance believes most borrowers will be able to weather the cost-of-living crisis: “While mortgage customers are not immune from these pressures, the industry will continue to offer competitively-priced finance to help their customers best cope. Further, the responsible lending rules in place since 2014 ensure that, with a built-in buffer against such shocks at origination, the vast majority of customers are able to refinance affordably this year, whether internally or on the open market.”
“Although our analysis suggests most will be able to cope, we do expect some upwards pressure on mortgage arrears as these pressures tighten, and this is likely to be concentrated amongst lower-income households.
“As always, we encourage any customers concerned about their ability to maintain payments to contact their lender at the earliest opportunity. The industry stands ready to help with a range of forbearance tools that can be tailored to best suit customers’ individual circumstances.”