The Fitch Ratings report stated this was because of rising interest rates, which were “almost exclusively” responsible for the deterioration of affordability since 2021. 

It stated: “Rising household income and recent reductions in house prices have had some offsetting effect, but high interest rates continue to be the main driver behind mortgage affordability.” 

It predicted this would recover going forward, depending on loosened monetary policy. 

 

BTL sector most exposed 

The Fitch Ratings report stated the buy-to-let (BTL) mortgage sector was most impacted by worsened affordability because of the prevalence of interest-only lending. 

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In 2023, the average interest coverage ratios (ICRs) on new loans fell to 195%, down from 300% in 2022, despite there being only a 5% reduction in the average loan to value (LTV). 

It stated if interest rates stayed higher for longer, the average ICR could fall to 175%. In the event interest rates fall, Fitch predicted that by 2026 the average ICR would near 250%, bringing it closer to levels seen in 2015. 

Fitch also said asset performance in the BTL sector suffered last year as the rate of loans in arrears doubled to 0.8%. 

“While coming from a low base, the deterioration takes the sector back to levels last seen a decade ago,” the report stated. 

Fitch predicted this could continue to get worse in 2024 as five-year loans secured in 2019 came up for refinance on a higher interest rate. 

It added: “Interest rate reductions, combined with increases in rents, will allow arrears in the sector to stabilise, although we do not anticipate the peak until 2025. This year, we expect a further increase in accounts in arrears to take the overall percentage above 1%, although it will remain short of the 2008 peak.” 

 

Higher-for-longer interest rates risk 

Fitch forecast housing and mortgage affordability would improve over the next three years as interest rates reduced. 

However, it said higher interest rates for longer put this at risk as borrowers came off historically low rates fixed between 2019 and 2021. 

Fitch said as rate cuts had already been priced into financial markets and fixed mortgage rates, the possibility of a material improvement in financial conditions could be “less than anticipated”, particularly if this was solely based on the bank rate expectations. 

“The single largest risk to our projected improvements is that policy interest rates do not decline as anticipated, causing fixed mortgage rates to rise as swap markets reprice,” the report found. 

Additionally, higher interest rates would reduce the share of rental properties and raise the proportion of owner-occupied homes. 

Fitch said this could bring some challenges, as although affordability was expected to ease, “mortgage payments will still consume proportionally more of a representative median households’ income than at any time since 2008 – excluding 2023”. 

 

A peak in mortgage costs 

Fitch said the deterioration in mortgage affordability last year was worse than expected due to average mortgage rates reaching 6% in Q3. 

“In relative terms, affordability reached its weakest point since the Global Financial Crisis,” Fitch’s report stated. 

It suggested last year was the peak of mortgage costs, as a proportion of household income and any improvements would rely on rising income and falling rates. Stagnating house prices in 2024 could also help with this improvement in affordability, Fitch said. 

It predicted house prices would return to growth in 2025 and 2026, with growth rates of 3% in each year.