Threadneedle Street said the number of households running into difficulties would increase by a third to 480,000 in the event of a two-percentage-point increase in the cost of borrowing.
The Bank stressed the proportion of borrowers having trouble paying their home loans should remain well below the levels of the early 1990s – when Britain suffered its worst postwar property crash – provided incomes rose alongside interest rates.
“Higher interest rates will increase financial pressure on households with high levels of debt,” the Bank said in its Quarterly Bulletin. “The percentage of households with high debt-servicing ratios, who would be most at risk of financial distress, is not expected to exceed previous peaks given the likely paths of interest rates and income.
“But developments in incomes for the households who are potentially most vulnerable will be an important determinant of the extent to which financial distress does increase.”
The findings were based on a survey for the Bank conducted by NMG consulting. It found that the average outstanding mortgage debt was £83,000 per household, with average household income of £33,000 a year (£43,000 for those with a mortgage) and unsecured debt £8,000.
Interest rates have been pegged at 0.5% – the lowest in the Bank’s 320-year history – since March 2009 and cheap borrowing costs have made it easier for households with large home loans to keep up payments on their mortgages.
The Bank has used its forward guidance policy to stress that interest rate rises, when they come, will be gradual and limited in size. Financial markets do not anticipate the first rise to come before the second half of 2015 but the Bank is exploring the impact of tighter policy on households where more than 40% of income is spent on mortgage repayments, since these housebuyers are most likely to fall into arrears.
“Assuming a 10% increase in income for all households, a two-percentage-point rise in mortgage interest rates would likely raise the proportion of mortgagors with a debt service ratio (DSR) of at least 40% from its current level of 4% to about 6%.
“The number of UK households in this vulnerable category would increase from about 360,000 to 480,000.But the impact would be more severe in a second, less likely, scenario where there was assumed to be no increases in incomes.”
Wages have been under pressure in recent years, but the Bank is assuming that the economic recovery of the past two years will create the conditions for rising incomes and higher interest rates.
“These experiments illustrate that, unsurprisingly, the outlook for household income is a key factor that will determine the vulnerability of households to a rise in interest rates. There is a risk that the most vulnerable households will experience lower-than-average income growth as rates rise.”
The Bank said official data showed that the ratio of household debt to income had fallen back from its peak in early 2009.
The debt-to-income ratio held steady at about 80% during the 1990s, rose steadily in the 2000s to peak at just over 130% and has since dropped to just over 110%.
“As usual, raising interest rates will have significant distributional consequences,” the article in the Quarterly Bulletin said.
“It will make borrowers worse off and savers better off, holding other factors constant. 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.”
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