Capital Economics’ latest housing market update has predicted that the cushion of capital buffers will prevent long-term problems in the banking system.
Its analysis found that banks now hold nearly four times as much capital to cover losses than they did in 2007, before the Global Financial Crisis. Additionally, the Bank of England’s stress tests suggest that lenders would “still be well capitalised” even with a 33 per cent drop in house prices and an unemployment rate of 12 per cent.
Capital Economics maintains its view that the base rate will rise to five per cent by next year.
However, senior property economist Andrew Wishart added: “But the fact that the housing market downturn will not cause a banking crisis means that house price falls won’t necessarily prevent the Bank of England from raising rates further if it needs to.”
Higher debt costs leading to arrears
Mortgage arrears and repossessions will increase as debt servicing costs rise due to higher interest rates and unemployment.
Pointing to the house price crash in the 1990s and the Global Financial Crisis in 2008, Wishart said each event followed the same pattern of a rise in mortgage costs, an increase in repossessions a year later then an uptick in unemployment levels in the year after.
While the majority of mortgage holders are on fixed rate terms of two or five years, the cost of interest payments is expected to rise from two per cent of household income to five per cent by mid-2024. Capital Economics said this was a larger rise than what was seen in the lead up to the 2008 financial crisis, but smaller than the increase in the late 1980s.
However, the research firm said arrears and repossessions may “not rise as far this time” as mortgage rates of six per cent would still be below the seven per cent affordability stress test rate which was in place since 2014 up until July this year.
Additionally, high loan to value (LTV) lending is not as prevalent, Capital Economics said, so negative equity would not affect people’s willingness to service their mortgage as heavily. Also, lenders are likely to offer “generous forbearance” to borrowers as they did during the height of the Covid-19 pandemic.
Despite this, a rise in arrears and repossessions is still expected because although rising expenses will still fall within a borrower’s affordability assessment limits, higher interest costs would reduce household income and affect a borrower’s ability to make ends meet.
Also, higher mortgage rates will lessen consumer spending and result in job losses, causing more people to fall behind on payments.
Capital Economics added: “Overall, we expect arrears to rise from 0.7 per cent of mortgages now to 1.6 per cent in 2024, and repossessions from 0.01 per cent to over 0.06 per cent of outstanding mortgages per quarter by end-2025.”
