UK’s mortgage measures could lead to a financial crisis in the future

Financial advisers warn that banks and building societies who help UK mortgage borrowers reduce their monthly payments could be storing financial problems for later on in life, when they are faced with a larger total interest bill and a lower retirement income.

After the surprise announcement of the Bank of England, it raised interest rates by a half-point to 5%, borrowers experienced another wave of rate increases last week. This will leave households who are coming off fixed-rate agreements in the months to come facing a “mortgage shock”.

The cost of products from major lenders such as Barclays Halifax, HSBC Nationwide NatWest Santander TSB Virgin Money, NatWest and NatWest have increased. Santander increased rates twice within a week.

The rise in mortgage rates has put pressure on the government. According to Oxford Economics, a homeowner refinancing their two-year fixed rate mortgage with a 25% deposit would be required to pay £580 extra per month.

In response to the BoE decision, Jeremy Hunt negotiated a deal with UK’s largest lenders for a mortgage charter designed to offer struggling borrowers options on how they can reduce — at least temporary — their monthly payments while their budgets groan from the weight of increased bills.

You can choose to switch from a capital-repayment mortgage to an interest only loan, or extend the term of your mortgage. This will spread out the repayments over a longer time period. Borrowers can request six months of the new arrangement without affecting their credit score. If they want to extend it further, they will need to take an affordability assessment with the lender.

This initiative may be a lifeline to those who are on the edge of being able to afford it. Property analysts and financial advisors are concerned that those who do not switch back to the old system could damage their finances over time.

The trend of extending mortgage terms past the 25-year norm is not new, especially among first-time homebuyers. Due to affordability tests and rising house prices, first-time buyers are increasingly taking out “marathon mortgages”, which can last up to 40 years.

According to the most recent data from UK Finance, the proportion of first-time buyers who took out mortgages with a minimum of 35 years has more than doubled in the past 12 months. It now stands at 19 percent. The trend was similar for those who were moving home, with the percentage of loans between 30 and 35 years increasing from a fifth up to a quarter.

It can be the only option for many to move up or onto the housing ladder. The result is that the total interest cost over the term of the mortgage will be higher.

If you assume a 3% interest rate over the term of the loan, an extension from 25 years to 35 would cost approximately £39,000. According to investment broker AJ Bell, a 10-year extension at £400,000 would cost an additional £77,500.

Laura Suter is a personal finance analyst at AJ Bell. She said, “Before consumers leap to benefit from the new flexibility, they should really consider the impact on the long-term.”

Adrian Anderson, Director at Anderson Harris, a mortgage broker, warns that the relief may not be quite as significant as many borrowers expect. If you are moving from a 2 or 3 percent rate to the current 5 or 6 percent rate, you will still be paying higher monthly payments even if you switch to an interest only mortgage. This may not be enough to save for many people. The mortgage crisis is also a concern for financial planners. According to official figures released in March, 38 percent of people working age did not save enough to ensure a sufficient income at retirement compared to their earnings before retiring. For higher earners, the figure increases to 55%.

Gail Izat is Standard Life’s managing director of workplace. She said that signing up for a mortgage with a term that extends to retirement only compounds the problem. I can see why adding an extra year to a mortgage would be a good idea. It does, however, exacerbate the savings gap. We need to consider how we can reduce this.

Gary Smith, partner of financial planning for Evelyn Partners’ wealth manager, is concerned that “quite a few” borrowers may fund higher mortgages either by reducing their pension contributions or using savings intended to be used in the medium-to-long term. “With inflation negating wage increases and stealth income taxes in operation, this could lead to a significant increase in mortgage costs.”

Reduced or paused pension contributions could result in the loss of employer contributions and tax breaks from the government. Without a plan to help them get back on track with their savings, they might need to work more to enjoy the retirement they planned.

Some people may be tempted by the chance to get a 25 percent tax-free lump sum when they turn 55 (57 in 2028).

Smith explained that this is not a new strategy, but the fact it leaves fewer savings for retirement incomes and could be due to mortgage pressures. With little certainty over when inflation might cool and allow interest rates to drop back, raised housing costs are “bound” to have a disruptive effect on saving, he warned, particularly if higher inflation proves more stubborn than expected.

The government has said that the best way to assist households is to reduce inflation. However, it has offered “significant” support for cost of living and implemented the mortgage charter to protect “borrowers and savings from rising costs.”

The statement continued: “We want to encourage saving for pensions and automatic enrollment has saved an additional PS33bn in 2021 as compared to 2012.”