The Bank of England has warned that mortgage costs will rise sharply for 4 million households, with an average borrower having to pay almost £3,000 more per year.
Andrew Bailey, the Governor of the Central Bank, said that the rise in mortgage rates would have a “clear impact” on the finances. The Financial Stability Report predicts that over 1 million households will face an increase in their monthly payments in excess of £500.
Bailey, speaking at a London press conference following the release of the report, said: “I’m afraid there will be still consequences from higher interest rates. From a monetary perspective, this is why we need to do it.” He said, however, that firms and households are less likely to cut spending or default on debts compared to previous periods when rates were high.
In the report, the assessment highlights the strain caused by the fastest series of rate increases in 30 years. The problems among landlords who buy-to-let are highlighted as a danger to house prices. This action will slow down the economy and reign in inflation but it will cause real pain to consumers who are already struggling with the tightest living standards for generations. This issue has become a major battleground for the UK’s main political parties in the run-up to the next elections, which are widely expected to take place in 2024. The government of Prime Minister Rishi sunak has been trying to find ways for savers to benefit from higher rates, and borrowers to have more flexibility when restructuring their finances.
According to the BOE, a typical household that leaves a fixed rate deal in 2023 will face an increase of £220 per monthly mortgage cost based on current interest rates. This is equivalent to£2,640 annually.
Around 1 million households’ monthly payment will be higher than £500 by the end of 2026. It is assumed that they refinanced at the same maturity. However, about 15% of homeowners have extended their mortgages. Some people are paying back their loans with savings, which reduces how many they refinance.
Bailey stated that it will take some time before the full effect of higher interest rates is felt in the UK as well as in other developed economies. Interest rates continue to affect certain elements of the global financial systems.
Moneyfacts reported that the average interest rate on fixed-term home loans has risen to 6.66% – the highest level since August 2008. Markets are pricing in an inflation-fighting peak Bank rate of 6.5%, which could make the pain even worse for homeowners.
The BOE’s comments and report suggest, however, that concerns about financial stability will not prevent further rate increases. Bailey stated that both lenders and borrowers are better prepared to handle difficulties than in previous interest rate cycles.
Bailey stated that compared to periods of high interest rate, businesses and households are less likely than before to reduce spending or default on loans. “More generally, the UK’s economy and financial system has so far proven resilient to interest rate risks.”
By 2026, the amount that UK households are required to pay for mortgages will rise to 8% from 6.2%. It is however still lower than the peak seen during the global financial crises and early 1990s recession.
The BOE stated that the burden of mortgage interest, when adjusted for living expenses, will likely increase this year. According to the BOE, about 650,000 households or 2.3% of all will be under significant stress. This is below the 2007 levels, which caused a steep drop in home prices. BOE stated that an exodus from buy-to-let landlords who are facing higher mortgage costs will threaten to affect house prices, as many of them consider selling their property. Some landlords have taken out mortgages with interest only and are now more vulnerable. Many are increasing rents to cover the higher costs.
Financial Stability Report stated that “Failing profitability could in principle cause landlords sell their property investments to exit the buy-to let market.” If this happened in enough numbers, it could lead to a downward pressure on the price of houses.
BOE stated that landlords, who will be facing an average increase of £275 in monthly payments by the end 2025, would likely raise rents to compensate for the impact. Private rents in the UK have already risen 5% over the past year, which is the highest increase since records began.
Cunliffe explained that landlords are leaving the sector because of the low interest rates in the buy-to let sector, which is now ending.
He said: “Now that we are in a time of higher interest rates, there is a lot of other return in other types of investments. You would expect some rebalancing to occur as we move forward.” The BOE’s Financial Policy Committee stated that while mortgage arrears are still low by historical standards they have been increasing. It will take time before the full effect of higher interest rates is felt.
The report said that a more resilient banking sector, and tighter regulations will limit mortgage defaults. In the UK, the impact of higher mortgage costs was also delayed due to a massive shift from variable rate mortgages into fixed rate deals that typically last two or five year.
Despite the surge in the cost of a two-year mortgage, Andrew Asaam said that the split between two and five year fixed mortgages has shifted more to two years, suggesting that borrowers are betting on rates falling.
Steven Major, HSBC’s global head for fixed income research told Bloomberg TV the BOE faces a “thankless” task in trying to reduce inflation and deal with mortgage rates that have a delayed impact.
He said: “Everyone knows there is a lag in the reaction of people who have fixed-rate mortgages. But we do not know exactly how they will react when they receive the shock.”