In its Financial Stability report for July, the Financial Policy Committee (FPC) of the Bank of England (BoE) said this was based on the current mortgage rate rises of 325 basis points.
The committee said around 4.5 million mortgage accounts had seen increases in monthly repayments since rates started to go up at the end of 2021. A further four million accounts are expected to be impacted by rate rises by the end of 2026, and the FPC predicted that one million mortgage holders would see a £500 jump in monthly payments by that time.
This includes those on a variable rate mortgage.
It said while more households were using consumer credit, mortgage and credit arrears had remained low. The probability of mortgage defaults may also be limited by forbearance measures, the committee suggested.
The FPC said there was evidence to suggest that households were extending their mortgage terms to reduce monthly payments. According to the committee, new lending terms at longer than 35 years rose from around five per cent in Q1 2022 to 11 per cent in Q1 2023. Furthermore, 15 per cent of borrowers who remortgaged in Q1 this year extended their existing term.
Share of income spent on debt
The proportion of post-tax income which is spent on mortgage payments is expected to rise from 6.2 per cent to eight per cent by mid-2026.
The FPC said if this happened it would be below the peaks seen during the global financial crisis in 2007 to 2008 and the recession which happened in the early 1990s, despite rates being at a similar level.
The UK household debt to income ratio is also lower than it was during the global financial crisis, at 118 per cent in Q1 2023 compared to 150 per cent in 2007 to 2008.
The committee also looked at the finances of households after tax and essential spending.
It found that households with higher mortgage cost of living-adjusted debt servicing ratios (COLA-DSRs), particularly those where it was over 70 per cent, were more likely to struggle with meeting debt repayments.
The FPC said a rise in defaults due to this could affect lender resilience.
There are more households with a high mortgage COLA-DSR, as this has risen from 1.6 per cent in Q3 2022 to two per cent in Q1 2023.
This is expected to continue to increase over the year to around 2.3 per cent or 600,000 households by the end of 2023. However, it will still be below the 3.4 per cent peak seen in 2007 when around 870,000 households were affected.
The committee said for households to be affected like they were during the global financial crisis, mortgage rates would need to rise three percentage points higher than they are now.
Buy-to-let to get less profitable
The FPC said buy-to-let mortgage holders had also been impacted by higher rates and mortgage borrowers could see average monthly payments rise by £275 by the end of 2025.
The committee said if landlords completely absorbed the higher costs, then the share of buy-to-let mortgages with interest coverage ratios (ICRs) below 125 per cent would increase from three per cent at the end of 2022 to over 40 per cent by 2025.
ICR measures a landlord’s rental income in comparison to their interest payments.
The committee predicted that a fall in profitably could lead to landlords selling up and exiting the market. It suggested that if this happened in large enough numbers, house prices could fall.
It said some of this could be mitigated if the properties disposed of by smaller landlords were purchased by professional landlords but added that it was hard to determine a “comprehensive view” of the overall impact on the housing market.
The report said: “However, available evidence suggests that recent market exit by some landlords has caused a certain degree of shrinkage of the private rented sector as a whole, but not on a scale likely to have a material impact on house prices overall.”
For landlords who pass the costs onto tenants in the form of higher rents, the committee said this could cause tenants to become more reliant on consumer credit and make renters vulnerable to “adverse shocks”.
UK banking system still resilient
The FPC said higher interest rates could pose a risk to UK banks as it led to tighter financial conditions and lower economic growth.
The committee said the UK banking system remained resilient and had the ability to support households and businesses through a higher interest rate environment or if economic and financial conditions worsened.
