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Millions face becoming ‘mortgage prisoners’ as interest rate rises would make loans unaffordable

04 June 2014

Millions face becoming ‘mortgage prisoners’ as interest rate rises to just 3% would make loans unaffordable

• 770,000 vulnerable households may struggle to renegotiate their mortgage payments when rates start to rise

• Base rate forecast to rise early next year

• One in ten mortgage holders could be trapped by unaffordable repayments

Millions of homeowners risk becoming ‘mortgage prisoners’ as interest rates start to rise, an independent think tank has warned.

As many as one in ten mortgage holders could be trapped by unaffordable repayments as interest rates rise over the next four years, the Resolution Foundation said.

Around 1.1million households are already facing unaffordable repayments today, and this could almost double to 2.3 million by 2018, based on current market expectations for interest rates.

Many of those facing affordability problems could look to refinance to secure some certainty over future payments. But there will still be an outstanding number who are unable to refinance and face significant problems as rates rise.

The study modelled the impact on households of an increase in the base rate from its current record low of 0.5 per cent to a predicted three per cent by 2018.

This puts rates at a far lower level than the 5 per cent level seen as the recent historic average in the decade running up to the financial crisis.

It found that around 770,000 vulnerable households will suffer from a limited ability to switch to a better deal and face the likelihood of their monthly repayments eating up at least a third of their disposable income.

It termed this type of households as ‘highly geared’.

These households could face difficulties renegotiating their borrowing ether because they have very low equity in their home (less than five per cent) or because they are self-employed or have interest-only mortgages, categories that make borrowers less attractive to mortgage providers.

The report found that these homeowners would have little option but to repay at their lender’s standard variable rate, leaving them fully exposed to any increases in the base rate.

The study predicts that this rise will begin early next year and will increase monthly repayments at the same time as lenders are setting more stringent conditions on borrowing.

Homeowners have benefited from six years of unprecedentedly low monthly rates, which have meant many have been able to keep up with payments despite falls in real wages and household incomes.

A household with a tracker mortgage of £75,000 over this six-year period has netted a cumulative gain of around £12,800, compared with the cost of meeting the same mortgage before 2008.

But if rises in incomes fail to keep up with increases to interest rates, households with high repayments could struggle.

The report comes after the Bank of England governor Mark Carney warned that a ‘big debt overhang’ is building up in the UK thanks to the booming housing market.

He warned the market has ‘deep structural problems’ that mean it represents the ‘biggest risk’ to the nation’s economic recovery.

He says the Bank is keeping a close eye on the market to see whether the rise in mortgage lending has the potential to destabilise the economy, and also expressed concern that borrowers are taking on mortgage debts that would suddenly become unaffordable when interest rates rise.

He also suggested the Bank is ready to wade in to the housing market if it finds that borrowers are taking on more than they can afford.

In an interview with Sky News he said: ‘The biggest risk to financial stability, and therefore to the durability of the expansion - those risks centre in the housing market and that’s why we are focused on that.’

The Resolution Foundation study also found that London and eastern England are most exposed to the affordability risk. An estimated 35 per cent of households will spend at least a third of their disposable income on repayments in 2018, compared with 18 per cent in Scotland and 19 per cent in Yorkshire and Humber.

The proportion of high loan-to-value loans surged just prior to the financial crash (Source: Resolution Foundation) Northern Ireland is also the region where low equity is most common. According to the study 35 per cent of mortgagors have less than five per cent equity in their home, compared to just two per cent in London.

Matthew Whittaker, chief economist at the Resolution Foundation and author of the report, called for greater consideration to be given to reducing the problems that rate rises will cause.

He said: ‘Many borrowers have enjoyed spectacular savings over recent years, with mortgage rates falling to historic lows, and most will be able to ride the tide of gradually rising interest rates.

‘But for around one in four, even modest rate rises could create financial difficulties. Those at greatest risk are members of this group who also find themselves unable to access the best deals in the market today.

‘Almost one in 10 households are doubly exposed: facing the prospect of their mortgage becoming increasingly unaffordable in the future and with the market offering them limited, if any, choice today.

‘There is still a window of opportunity to think creatively about the best way of reducing the risk to this vulnerable group while we still have ultra-low interest rates. But that era is coming to an end relatively soon and the legacy of easy credit and the associated debt-overhang will have to be reckoned with.

‘Financial institutions and policy-makers must consider now how best to minimise the scale of the adjustment problems these families face when interest rates start to return to normal.’

Article Reproduced from This Is Money

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