Interest rate rises would tip millions of already-precarious households into financial disaster, according to economists, who warn it would cost the average family nearly £3,000 a year in extra mortgage payments if rates returned to levels that were typical before the credit crunch.
The Resolution Foundation thinktank has forecast that about 1 million households would face perilous debts if Bank of England base rates rose to 3%, with 2 million forced to spend more than half of their income on servicing a mortgage if rates returned to the 5% level common before the onset of the financial crisis in 2007.
British households remain among the most indebted in the world, warned the Trades Union Congress, and with wages falling in real terms they have struggled to pay off loans taken on during the boom.
"We will start seeing really serious stress on household budgets if [Bank of England base] rates rise to 3.5-4%," said a TUC senior economist, Duncan Weldon.
Worst hit would be holders of interest-only mortgages who enjoyed huge falls in monthly costs when rates fell to historic lows – but who would see costs boomerang if rates rose. The lucky householder whose tracker mortgage follows base rate plus 1% would see the cost of a £150,000 interest-only mortgage soar from £188 a month to £500 a month if base rates rose to 3%, and to £750 a month if it hit 5%.
Households with repayment mortgages saw their bills fall less during the financial crisis and would in turn see less of a painful increase. Someone with a £150,000 repayment mortgage currently on a tracker rate of 2.5% would see their costs rise from £673 a month to £877 a month if rates went up to 3%, and to £1,060 if they hit 5%.
The house price boom in London and many parts of the south will swiftly go into reverse if rates rise – although for now most economists are projecting increases of 5% or more in 2014. But Phil Lachowycz of Fathom Financial Consulting, which has warned about the implications of rate rises, said: "We think there is a housing bubble not just in London but across the country, yet the government is still encouraging people to take on debt through schemes such as Help to Buy. Households are still very indebted and we don't need much of a rate rise to tip the housing market into reverse."
Lachowycz expects a rise in inflation later this year, caused by the economy hitting capacity constraints, to put intense pressure on the Bank of England to hike interest rates.
Arrears and repossessions were the dog that didn't bark during the financial crisis, with households rescued by falling interest costs. Although the numbers in arrears rose between 2007 to 2009, they have fallen since and remain a fraction of the levels witnessed during the housing crash of the early 1990s.
The Council of Mortgage Lenders (CML) said arrears fell in 2013, with just 149,000 households (1.33% of the total) in arrears worth 2.5% of their mortgage or more, compared with more than 400,000 in 1995. It also recently revised downwards its projection for repossessions in 2014 to below 37,000 homes.
Lenders have praised early action by the Labour government in 2008, which launched a mortgage rescue scheme to avert a sudden rise in repossessions, but are concerned about the impact of its removal in March.
The director general of the CML, Paul Smee, said: "As the government's mortgage rescue scheme in the English regions closes to applications at the end of March, we will be sorry to see it go. While the 5,000 households helped directly through mortgage rescue may seem relatively small, the benefit to those households was huge."
But it may not take a rise in the Bank of England base rate for mortgage rates to start moving up, and with the Funding for Lending scheme being redirected to small businesses, mortgage deals are expected to become less attractive. Recent months have seen a rush of applicants for longer-term fixed-rate mortgages, with five-year deals available at rates of under 3% for buyers or remortgagers with lots of equity in their home. The CML said a record nine out of 10 borrowers were opting for a fixed-rate deal rather than a tracker mortgage that would rise in line with Bank of England rate increases.
Not everyone is upset about the prospect of rate rises, especially the millions of older people who rely on their bank and building society deposits to supplement their income.
A spokesman for the independent action group Save Our Savers, Simon Rose, said: "Savers and pensioners would be delighted if interest rates were to rise in the near future. Many of them depend on their savings for their ability to survive, and they have been incredibly hard hit. But I think the Bank of England will delay putting up interest rates for as long as possible, and in the end we think they will be forced to raise them because the economy is growing too strongly."
What the experts say:
TUC general secretary Frances O'Grady:
An early interest rate rise would clobber mortgage holders and businesses – jeopardising our economic recovery. Patchy levels of jobs growth in parts of the north and the continuing squeeze on living standards should make the Bank of England think twice before considering a rate raise.
Phil Lachowycz of Fathom Financial Consulting:
Households are still very indebted, and we don't need much of a rate rise to tip the housing market into reverse.
Andrew Smith, Chief Economist at KPMG:
Given that inflation has finally come down to target and that the economic recovery is still in its early stages, it would be perverse to do [raise rates] and as unemployment falls through 7%, the committee is more likely to change its guidance than raise interest rates.
Andy Scott, currency dealers HiFX:
Expectations of a hike next year will continue to make sterling look attractive, particularly against the euro, which could still see monetary policy eased due to very low inflation.
Simon Rose, a spokesman for Save Our Savers, an independent action group:
Savers and pensioners would be delighted if interest rates were to rise in the near future. Many of them depend on their savings for their ability to survive, and they have been incredibly hard hit. But I think the Bank of England will delay putting up interest rates for as long as possible, and in the end we think they will be forced to raise them because the economy is growing too strongly.
Dan Wilson Craw, spokesman for PricedOut.org:
While rising interest rates would increase the cost of mortgages, for most would-be first time buyers the real problem is already-high house prices rising far faster than wages. Higher rates could help dampen competition over the limited supply of homes, and also help those who are striving to save a deposit on their first home.
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