Sir Mervyn King, the outgoing Governor of the central bank, gave a stark warning about interest rates recently. He warned that the high levels of mortgage debts of homeowners in their 30s and 40s meant that if the Bank of England raised interest rates by just one percentage point, millions of people would be pushed into an ‘unsustainable’ position and that nearly one in ten mortgage borrowers would have to take significant action – such as working longer hours and cutting back on essentials.
His comments are worrying; a significant number of households appear to be in a precarious position already as shown by the Council of Mortgage Lenders (CML) repossession and forbearance statistics.
What is the current state of mortgage debt and arrears?
Despite the fact that interest rates have been at an historic low rate for over four years (0.50%), the outgoing Governor said that many homeowners faced a debt time-bomb because they had failed to use the opportunity of record low interest rates to reduce their mortgage debt. Rather than reduce debt, information from the CML shows that many households are struggling to maintain payments at the current low rates.
CML statistics show that a total of 8,000 properties were taken into possession in the first quarter of 2013 and the latest CML forecast is that there will be a total of 35,000 repossessions in 2013. Coupled with this there are 160,000 mortgages which are in arrears of 2.5% of the mortgage balance or more! Clearly, mortgage affordability is already an issue and it is not surprising that claims management companies (CMCs) have seen a rise in mortgage mis-selling claims.
Why are we in this position today?
There will be those who will not understand why households are in the position they are currently in The background is complex.
Standard Variable Rate mortgage prisoners!
Firstly, it should not be forgotten that the Bank of England base rate at the peak of the last housing boom was at 5.75% (September 2007) compared to a rate now of 0.50%. But such comparisons paint a misleading picture. There are hundreds of thousands of borrowers that are trapped with their existing lender and stuck paying a standard variable rate (SVR) mortgage because they cannot remortgage to a cheaper lender. SVR is often disproportionately high compared with bank base rate so the current low bank base rate gives a misleading impression of the mortgage interest rate customers actually pay.
The cost if interest rates rise
Secondly, lenders and brokers were, since October 2004, required to assess mortgages on an applicant’s ability to afford a loan when advising on the suitability of a mortgage. The requirements are detailed in rules that they are bound by (Mortgages and Home Finance: Conduct of Business sourcebook – MCOB). All applicant’s, since October 2004, have received a statutory information sheet about the mortgage they were arranging call a Key Features Illustration (KFI). The KFI not only gave details of the cost of the mortgage being arranged, but also gave the cost should interest rates rise by one per cent. For so many properties to be repossessed and for many people to be so far in arrears it is obvious that little notice was taken of the affordability requirements.
No consideration of long term affordability
The governor is not critical of the borrowers in their 30s and 40s who took on significant debt during the last decade as they aspired to buy better properties at a time of rising prices, but his warning does suggest they have done little to reduce their debt while bank base rates are at an historic low and that little consideration was given to long term affordability at the time the mortgage was arranged.