Borrowers on the whole will be able to cope financially even if they remortgage onto a higher interest rate, the central bank’s committee said.
The Bank of England’s Financial Policy Committee (FPC) said in its Financial Stability Report that the aggregate household debt to income ratio fell by around four percentage points to 126% from Q2 last year to Q4 last year, the lowest level since 2001.
It said higher incomes and lower interest rates meant that overall, the share of household income spent on mortgage repayments was not expected to rise significantly.
The aggregate mortgage debt-servicing ratio (DSR), the proportion of household income spent on mortgage repayments, was flat at 7.1% in December last year and was expected to rise slightly to 8% by the end of 2026. It will then increase to 8.7% by the end of 2027.
The proportion of households in arrears or with high debt-servicing burdens remained low by historical standards, the FPC said.
The share of all households with high mortgage cost of living adjusted DSRs, over 70%, was 1.3% in the first quarter of this year. This is expected to remain below the global financial crisis peak and was lower than the prediction made by the FPC in November.
How to get your first-time buyer clients mortgage ready
Sponsored by Halifax Intermediaries
Further, the rate of mortgage arrears was 1% in Q1, and is expected to stay below peaks seen in early 1990 and after the global financial crisis. There were also indications that households are saving more, increasing their resilience to future shocks.
The FPC assessed that it would take a large fall in incomes and a significant rise in interest rates for DSRs to reach the highs seen during the global financial crisis.
A smaller rise in payments after remortgage
Since its November report, the FPC noted that the share of mortgages which had been refixed since rates started to rise in the second half of 2021 had increased. However, around 30% of these mortgages are yet to refix, so the full impact of higher rates is yet to be felt.
It projected that between June this year and the second quarter of 2028, 41% or 3.6 million, mortgage accounts would refinance onto higher rates.
This is less than the 50% set to refinance onto higher rates over three years as predicted in the FPC’s November report.
For other borrowers, past and future falls in the base rate will result in lower mortgage repayments. Some 28%, or 2.5 million, mortgage accounts will see payments fall between the stated three-year period. This is marginally higher than the 27% expected in the last report.
Around 1.5 million, or 16%, of all mortgages are on variable rates, while the remaining one million are fixed above prevailing rates.
The FPC said the average homeowner coming off a fixed rate in the next two years would see their monthly payments rise by 14% or £104, compared to the projected 22% or £146 in the November report.
Most first-time buyers locked out the market
Commenting on the impacts of proposals to change mortgage lending policy and the loan to income (LTI) flow limit, the FPC said house prices were high relative to incomes and homeownership rates had been flat since 2014.
It said this meant first-time buyers needed both a large deposit and loan relative to their incomes to access a mortgage.
Last year, first-time buyers paid deposits which accounted for around 60% of their household income.
Despite this, the share of new lending to first-time buyers stayed high, at 53% as of Q1 this year, having risen from 33% before the global financial crisis and was near its highest point since the early 1990s.
It said high deposit requirements were a barrier to first-time buyers, and 78% did not have enough savings for a 5% deposit on an average-priced typical first-time buyer’s property in their local area.
Some 6% would be able to raise a deposit but not meet affordability tests, if stressed at 7%, or would need a loan above the lender’s LTI ratio cap, typically around 5.5.
A further 1% would not meet the requirements to access high-LTI lending, such as minimum income. The remaining 15% would not be limited by these factors, the FPC said.
It said that although looser credit conditions could allow more borrowers into the market in the near term, unless housing supply increased, this could push up house prices in the medium term without improving homeownership rates.
Room for more high-LTI lending
The analysis found that the aggregate share of high-LTI lending reached 9.7% in Q1 and was below the FPC’s flow limit of 15% on a four-quarter basis.
This could rise to 11% by the end of the year following changes to the flow limit, due to lower interest rates. Even if high LTI lending rises to this level, the FPC said there would still be a headroom of 4% to the aggregate 15% limit.
Therefore, lenders overall will be expected to continue having the capacity to lend at high LTI ratios, even though some lenders may be close to the 15% limit on an individual basis.
The FPC looked at how household resilience could evolve and determined that more high-LTI lending would not result in a material increase in borrowers with high DSRs.
The committee said the 15% aggregate flow limit would be appropriate to protect against risks to financial stability and household over-indebtedness.