How badly would UK mortgage borrowers be affected by a rise in interest-rates?

A major feature of the credit crunch era has been the reduction of many official interest-rates to what often euphemistically called the lower bound. In the past this was usually assumed to be zero –  for example I worked in futures markets for short-term interest-rates where the maximum price of 100 meant 0% was the minimum and hence we have the acronym ZIRP for Zero Interest Rate Policy. Of course regular readers of this blog will have been aware for some years that I expected the ZIRP barrier to fall and the expected candidate the European Central Bank has an official rate of -0.2% as I type this.

The Bank of England has,like in so many areas, had a confused view of events as illustrated by its Governor Mark Carney regularly telling us that the lower bound for Base Rates in the UK is 0.5%. Has he never looked across the Channel to the Euro area. He also regularly yo-yo’s between telling us a Base Rate rise is near and one is far away. It is in the light of these matters that I note the latest Bank of England Quarterly Bulletin has an article entitled as shown below.

The potential impact of higher interest rates on the household sector

Is that a euphemism for higher mortgage rates? Let us investigate further.

What is the state of play as regards debt?

The situation according to the Bank of England survey is shown below.

The latest NMG survey suggests that the size of the average outstanding mortgage was broadly unchanged over the year to September and stands at around £83,000. For those with unsecured debt, the average amount of debt outstanding was reported to have increased a little over the past year, to around £8,000.

Just to be clear the average mortgage debt is for those who have a mortgage and the unsecured debt average only applies to those who have unsecured debt.

In terms of the ability to support such debts then the income situation is as follows.

Households also reported modest increases in income relative to the 2013 survey: in the latest survey average annual income before tax was around £33,000, although it was somewhat higher for mortgagors at around £43,000.

The impact of higher interest-rates

Typically the Bank of England is concerned first about the impact of higher interest-rates on financial stability otherwise known as the banking sector. However it then looked at the impact on households. The actual changes are described below.

The analysis in this section is based on a scenario in which
Bank Rate rises immediately by 2 percentage points. This
increase in rates is assumed to be passed through to
households in full, and unless otherwise stated, household
income is assumed to remain unchanged.

In these times a 2% increase in interest-rates seems quite a lot does it not? I would imagine it was chosen because Governor Carney has suggested Base Rates might eventually rise to 2.5% in the UK. That is of course on the even days of the month when rate rises are on their way as opposed to the odd days of the month when they are not.

Anyway we find that an old friend really matters as to what impact we see and it is something that if a big issue in the credit crunch era.

An estimated 37% of mortgagors would need to take some
kind of action if interest rates rose by 2 percentage points
while income remained unchanged , equivalent to 12% of all households. This is somewhat lower than a year ago . But if the income of all households were to rise by 10%, the proportion of mortgagors that would need to respond falls
to only 4% , equivalent to 1.3% of all households.

If you read elsewhere that the Bank of England is sanguine about the economic effect of higher interest-rates this is because they are using numbers where the wages fairy has been busy. As we stand right now the wages fairy has been rather absent over the credit crunch period and only on Friday I discussed the International Labour Organisation’s views on this issue.

What about savers and borrowers?

Sadly the Bank of England has copy and pasted old orthodox theory on the impact of changes in interest-rates on borrowers and savers.

The survey responses suggest that, when interest rates rise,
the average MPC of borrowers out of higher interest payments is expected to be around 0.5……..The
average estimated MPC of savers out of higher interest
receipts was much smaller, however, at 0.1, implying that they would spend only £1 more for every £10 of extra savings income.

I would like to see more research in this area as the cuts in savings rates have been savage and there must be many people who relied on savings income who have been hit hard. Therefore I would expect them to pretty much spend any extra income.

The Bank of England uses this research to conclude that a rise in interest-rates would have only a small effect on the UK economy.

Overall, these results do not imply that increases in interest rates from their current historically low level would have unusually large effects on household spending……And a 2 percentage point rise in interest rates could reduce spending by around 1% through this channel (a redistribution of income from borrowers to savers (the
cash-flow effect).

In these times of economic difficulty a 1% reduction in household spending would lead to even more deflation paranoia in my opinion.

The generation game

We do get some thoughts from the Bank of England on the distributional impact of an increase in interest-rates on different age ranges. The group most adversely affected is shown below.

On average, the reduction in income and spending is likely to be larger for households aged between 25 and 44, since they are more likely to be borrowers.

And the relative winners?

But higher rates would increase the income of older households, on average, since they are more likely to be savers,

Actually if we wish to put it relatively simply the threshold us age 55.Those younger lose and those older gain. Oddly the Bank of England seems to think that those who gain in the 55-64 age group will not spend an extra penny! However one analyses it the starting gun is potentially fired on something of a generational war.

On average, younger households, who are more likely to be
borrowers, will be worse off, while older households, who are more likely to be savers, will gain.

Comment

There is much to consider from this research by the Bank of England. However the days when central banks were relatively independent arbiters of events are long gone.We can no longer consider them to be what used to be called disinterested like say John Jarndyce of the novel Bleak House. Therefore any research needs to viewed through a reader which allows for their own spin on events. So what do we see?

Firstly the Bank of England has launched an ongoing campaign against savers. It cut Base Rates to 5% and reduced longer-term interest-rates via its purchases of UK government bonds. Back in September 2010 Deputy Governor Charlie Bean told us this in a Channel 4 interview.

Indeed when asked this question.

This bad news for savers is the point of what you are doing?

He replied “yes”.

 

After that the Bank of England added to savers pain in the summer of 2012 with the Funding for (Mortgage) Lending Scheme which drove savers and depositors interest-rates even lower.

Secondly this sort of partial analysis of generational issues ignores the fact that younger people are the victims of something that very low Base Rates have contributed to. That is the rise of house prices without any similar rise in wages. If we look at the fall in UK real wages of approximately 10% and then the rise in house prices then we might even argue that they have been “crowded out” to use a phrase rarely heard these days. If we add in the rise and rise of student debt burdens -only perhaps affordable at such low interest-rates then the gain for them seems more like a ball and chain.

Thirdly this sort of analysis that a 2% rise in interest-rates has double the impact of a 1% rise is at best laughable. If we go back to when Base Rates were 5% and applied such analysis then the cuts to 0.5% would have “saved” us. But they did not! My contention is that two factors were at play. Firstly the rapid and savage cuts disturbed people and changed their behaviour which offset some of the expected gains. Secondly that as we approach zero interest-rates (from around 2%) a bit like in quantum theory physics reality changes. The gains from interest-rate cuts become very limited and run the danger of becoming losses.

Finally I suspect that this research was commissioned back in the days of the Mansion House speech when Governor Mark Carney hinted heavily at Base Rate rises. Accordingly it would appear that the official view of their impact needed “adjustment”. Now such work is published the “dedicated follower of fashion” has moved on to pastures new.

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28 thoughts on “How badly would UK mortgage borrowers be affected by a rise in interest-rates?

  1. In 1997, I bought my first house with an affordable (for me) mortgage of 102,000 @ approx 9%. The 40% higher rate of tax kicked in at 25,500 PA -> so it penalized less than 50% of households.

    Roll forward to 2014, not only do mortgages (for houses) need to be much higher, but the average mortgagor income of 43,000 is being badly penalized by hefty intermediate 40% rate of tax. In short, fiscal drag is hurting ordinary young working families.

    • That’s nonsense.
      £43,000 is likely to be joint income.
      Young people on £43000 are very fortunate, and should think themselves so.
      Indeed to have that salary whilst young suggests that they are beneficiaries of the growing inequity in this country and DESERVE “fiscal drag”.

      • the government definition of young is under 35

        or was it 40 ?

        please bare that in mind and how much should a 25 year old earn to afford a house in the South yet alone London ?

        would 86K joint on a 3.5 mortgage at 15% be enough ?

        the circumstances we see are the EMERGENCY ones , it about time we went back to normality ( “and we will be restoring normality just as soon as we are sure what is normal anyway.” ! Star ship Heart of Gold )

        but hey ho as if we can do anything about …..

        Forbin

        • “…it about time we went back to normality” – no such thing, only the here and now. Older guys were probably saying the same as this 40 years ago when mortgages were drifting towards 3 times annual salary.

        • well I suppose Mr Bean did point out that we’ll have mortgages passed from father to son ( mother to daughter ) because house prices will just keep on going up

          multi generational mortgages for a 100 years or more

          what price freedom then ? When your indentured to the Banks …….

          no I’m not joking

          Dune

          Forbin

        • The facts are simple.

          People receive their income NET of tax.
          home affordability was better in 1997, middle class families could buy a house on a single income.
          middle class effective tax rates were lower in 1997
          National finances were in good shape in 1997.
          Final salary pension schemes were widely available.

          Gordon stole from the pension funds, despite being warned that would hurt pension schemes.
          Gordon adopted CPI – remind me, how did that work out for housing affordability ?
          Tony embarked on several very expensive neocon wars, resulting in the deaths of many British servicepeople.
          And the top 1% just got much richer.

          The tony & gordon show was a disaster for Britain, in an effective democracy their party would be electorally eliminated. Sadly for Britain, voting choices are too often blindly partisan. Like Progrock, I’m glad to have left ….

  2. The very same folk who will be affected by a rate rise are those who have enjoyed a nice capital gain whilst rates were low – should we feel sorry for them if they have over extended themselves to maximise this gain? Having supported the profligate banks surely the B of E is not now going to hold of rate rises to support borrowers! Mr Macawber would be horrified!

    • AS if I , who only has a home , have benifitted at all from the rise in house prices whilst my income declined – pffft!

      richer ?

      bu@@er off mate !

      For the legions of BTL – tax them to hell !!

      ( oops sorry didn’t mean to get irate ! )

      Forbin

      PS: When I see plans to build 20 million houses in the South of England in the next 10 years then maybe we’ll see and end to this madness

      but I aint holding my breath

      • How will you supply those 20 million homes with water?
        How will you supply them with electricity?
        Face it, there is no prospect of building huge numbers of homes in the SE to service the economy of London until a water pipeline runs from Scotland to SE England.

        Hence HS2.

        • ‘buzzin

          I made that point last week , essentially we have and engineering problem and what is our illustrious HMG doing about it ?

          Well basically hoping the next mob in get the problem whilst shouting yah boo from the bench !

          pfft!

          Forbin

          PS: following the Hong Kong example for the south of england we get 1/2 billion , so do we engineer for that or perhaps we say theres too many people ( and watch yer back when you say that ! )

  3. Brilliant article Shaun, and one which deals with issues that have been the subject of a fair amount of thought for me very recently.
    Firstly,whilst I would agree that younger people DO, in general, suffer as you say, I think the waters have been muddied by the necessary help that has been very often given to younger people by their parents in housebuying, especially as the banks have required much higher deposits.
    Indeed, with annuities plummetting in value, and no income to be had from savings, it may well be the case that the help has come from parents’ MEWS, which may cause difficulties for them if rates rise.

    Further, because of the huge falls in annuities, far fewer of those retiring will have been able to have afforded to take indexed annuities, so rises in inflation will not help with their debt.

    In general, although my thoughts are still nebulous, and I’m not an economist, it looks ever more likely to me that our economy is in danger of becoming PERMANENTLY entangled in the web that TPTB have woven, whereby interest rate rises do not compensate for higher interest rate levels for an ever-increasing number of people, from across the demographic, and so would render more and more housing loans bad debt, not what the banksters want at all.

    So although Govts. would love to inflate away their debt, their seems to me to be a link between zirp and low inflation that, the longer it exists, the less we dare break it.

    Since it seems obvious to me that the longer we’re in ZIRP the harder it will be to get out of it, it may be the case that Zero Inflation Policy eventually becomes a necessity.

    • Hi therrawbuzzin and thank you.

      The problem with the bank of mum and dad is tha it is only available for those with parents of a certain means which begs the question of a type of underclass. Also as you suggest some borderline parents may suffer from the consequences of overstretching themselves.

      You are right about recent annuities although those with past annuities have ended up an an environment (depending how long we see lower inflation) which is favourable for them.

      As to the current situation then yes we are in a “spiders web” as Coldplay put it in the song Trouble. ZIRP to NIRP?

    • > looks ever more likely to me that our economy is in danger of becoming PERMANENTLY entangled in the web that TPTB have woven,

      If they get out of this I’ll buy a hat and eat it. Nailed on to collapse. Just look at the demographics.

  4. The two figures which jump out at me are average household income of £43k and average mortgage debt of £83k!

    …and they expect me to take the rest of their report seriously? One part of the research done in London and the other in Scotland I presume?

    • Hi Zak

      The mortgage data included those who had possessed one for quite some time so included those who for example were 20 years into it and had paid a lot of it down. To my mind they were mostly unlikely tobe hit hard by a rate wqrise due to their likely equity and paying back of debt. Some may be caught for example if they have an interest-only mortgage but I would have wanted to know the position of newer borrowers.

      Surely it is th newer mortgage borrowers who would represent the group likeliest to be hurt by rising mortgage rates and that is where I would have concentrated my research.

  5. Shaun,
    BoE now operating CYA reporting – mortgage difficulties if rates rise! So many assumptions what about risk premium on interest only mortgages if rates rise?
    Deficit reduction plans based on more personal debt so how does this sit with interest rate rises?

    • Hi Chris

      You make an interesting point. How would the government respond to a 2% rise in Gilt yields? If the ten-year Gilt benchmark went from 2% to 4% then the UK fiscal arithmetic would unravel (even further).What were the debt savings in the Autum Statement some £18 billion I think? So we would instead have more than £18 billion of extra expenditure.

  6. Holy Cow , Shaun !

    yes I can see I can get a mortgage for a low as 0.99% for 2 years but 3.99% afterwards so long as I can stump up 40% deposit !!

    and

    Flats sold for an average of £214,014, with detached properties fetching £513,993.
    South East, with an overall average price of £322,362 , this is not London btw.

    And with 26.8 K average earnings

    ( btw women earnt about half what men earnt according to the figures for the SE, National averages are different ! )

    ratios , flats 7.9 for single and for a couple its 5.3 ( 45K )

    take home is 36k approx

    for that coverted house joint its 11.4 ratio …..frig and odin , who’s buying these things ?

    average ration 322/45 = 7.16

    stump up for that flat 85K and pay 129K mortgage , 1277 pa that rises to 5147 pa ( variable btw)

    hmm, not too bad , if mom and dad help …..

    at 95% LTV though its 3.99% rising to 5.0 plus !

    thats 11K down and 203k to pay , 8111 pa and 10145 pa

    average house ? 129K deposit from previous purchase and 193K , 1910 pa rising to 7700 pa

    add in food , heating and taxes …….

    Now raise that by 2 % …… and 10145 becomes 14210…. for you average flat buyer.

    ( historical note : I had a 45K one bed starter home in Datchet that at an average of 9% cost me 3879pa of my 10k take home pay (14K I think gross) , oh and that went to 15% one year 😉 )

    will this all work out?

    who knows ….

    Forbin

    • Yes Forbin, you’ve just described my housing start too – my monthly payment increased by 90% whilst my take home pay went up 20%. Almost lost the house and there were 70000 repossessions a year at the time all against a back drop of 15% BASE RATE to …er…control an 8% INFLATION RATE!!!and no – one gave borrowers a moments thought.

      Frankly I have no time for buyers merely looking at their monthly payments with no attention paid to price paid. They have the precedent set by Thatcher in 88- 90 to use as a lesson. You and I had no such previous historical lesson of which I am aware to consider. Quite simply interest rates are way too low and should be around 5% for mortgages and 4% for 1 year time deposits if a more vibrant sustainable economy is the goal. .

      • Noo

        I think one of my points was that mortgage rates are already 4-5% for first time buyers

        perhaps 9% was the intended rate you were thinking of ?

        ( not forgetting the Banks are financed by 0.5% BoE rates , perhaps thats why savings rates are so low…… oh and to finance our government !

        Cheers

        Forbin

        • Sorry, I failed to make my point which is about the “special offers” of circa 1% – 2% for first 2/3 years. These should be banned as I believe the borrowers sign up knowing they can’t afford the current “normal” 4% – 5% thinking another cheap deal will come along by the end of their current special offer. That was one of the problems of sub prime lending in the US and here we are as if it never happened!

  7. Completely off-topic but I see that Kaupthing’s creditors are waiting to hear the (bad?) news on how much of their loans they are going to get back. it seems that these creditors, represented as they are by Timothy Coleman the senior MD at Blackstone Group, have high hopes for an equitable solution and will simply refuse to be fobbed off.

    “They will use every part of every legal system available to them to ensure that they are treated appropriately and fairly.”

    Mind you, I’m not quite sure how comfortably they’ll be sitting after reading this bit …

    “The debt against Kaupthing is trading below 30 cents on the dollar, so” creditors “understand there will be some negotiated cost,” Coleman said. Bondholders have three demands, he said:

    “The creditors want to secure a solution that respects the people of Iceland and their capital controls. That would be number one,” he said. “Number two would be to be paid back the money that they lent to the Icelandic banks. And, number three, the creditors have an expectation that they will be treated in accordance with international banking standards.”

    ” … treated in accordance with international banking standards” … Forgive the cynicism but does this mean deception, fraud and bare-faced lies?

    http://www.bloomberg.com/news/2014-12-07/iceland-tests-hedge-funds-as-showdown-with-creditors-arrives.html

    • I presume they mean by this

      ” … treated in accordance with international banking standards”

      by economic Gun Boat then ?

      Iceland refused to bail out their Banks , as PLC s with convicted CEOs , I take it that no money will be paid back by the Icelandic people as in accordance with company law ?

      perhaps I being too naive ?

      I dont think this is Argentina here

      interesting times !

      Forbin

    • Hi Jim M

      The phrase “nternational banking standards ” does make me think. If we had a poll as to what that means I think we know what they would be! By the way thank you for Stewart Downing who was one of the few successes for my fantasy team this week.

  8. Anyone with an ounce of intelligence can see how deeply flawed and false the so called NMG surveys are.I seems clear respondants are cherrry picked, number of respondants in each age group is not revealed and theres zero proof it matches actual population.
    Sources of income are not differentiated
    Responses are all online which will exclude millions of elderly who do not have computer access and whose incomes are derived from savings as opposed to pensions

    The B of E refuse to obey instructions from TSC to calculate losses sustained by savers
    Funding for Lending has destroyed savings interest rates and means those dependant on savings have lost 70% of their incomes

    How can that kind of deliberate robbery perpetrated by B of E not have had a devastating effect on the economy
    ITS POLITICS OF THE MADHOUSE

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