Writing for the Bank of England’s Bank Underground blog, Fergus Cumming, deputy chief economist at the Foreign, Commonwealth and Development Office, and Danny Walker, private secretary and chief of staff at the Bank of England, said a 10 per cent drop in house prices could put 350,000 mortgagors above 75 per cent LTV.
The report said this would have a “material impact on the economy” as it could increase their mortgage payments by an extra £2,000 each year.
The economists said because of the risk of negative equity, higher LTV mortgages were priced higher and during the 2010s, the difference between a 90 per cent deal and a 75 per cent mortgage was around one and two percentage points.
However, as of August this year, the differential had narrowed to 0.4 per cent. The blog said the gap had started to get closer in 2021.
Because high LTV mortgages “look relatively cheap compared with recent history”, it was likely that 90 per cent LTV mortgages could return to the spread seen before 2010, the blog said.
A recalculated LTV
The economists based their scenario on a 10 per cent drop in house prices and a 100 basis points (bps) rise in mortgage rates. By comparison, in 2007 to 2009 during the financial crisis, a 90 per cent LTV rate was more than 2.5 per cent higher than a 60 per cent LTV and house prices fell by around 20 per cent.
Cumming and Walker assumed that all mortgagors would refinance at a higher rate and noted that, at origination, around 40 per cent of mortgages need not meet the 0-60 per cent of 60-75 per cent LTV band.
They said roughly a quarter of recent mortgages, or 800,000, were above the 75 per cent LTV threshold.
With a 10 per cent decline in house prices, they said this would put 350,000 more mortgaged households above the 75 per cent LTV bracket, accounting for 1.1 million or 40 per cent of recent mortgagors. They also wrote that this would push three per cent of mortgagors into negative equity.
Economic impact
While this would add £2,000 a year to mortgage costs, Cumming and Walker asked what impact this would have on the economy.
They said compared to the current base rate, the scenario seemed “relatively modest” as a 100bps rise was less than a quarter of the increase in swap rates that have taken place. They said this also only affected two-fifths of recent mortgagors and a tenth of all mortgagors.
It said their additional burden equated to around a fifth of the repayment increase caused by the higher base rate.
However, they acknowledged that financially-constrained households would be most impacted.
Otherwise, for mortgage holders with the most leverage, Cumming and Walker said the repayment increases had “already baked in”.
