Britain, land of the eternal mortgage

The philosopher Ice Cube once said “life ain’t a track meet, it’s a marathon”, wisdom that increasingly applies to UK mortgage borrowing.

With 2-year rates on house loans topping 6 per cent in recent days, warnings of a mortgage apocalypse have been dominating the British press, a process that looks something like this:

(There’s an excellent piece on renters by mainFT’s Joshua Oliver here; we’re gonna talk about mortgages anyway.)

FT Alphaville wrote about the Bank of England/gilt market side of this equation yesterday and last week, but the UK, it turns out, is endlessly fascinating. Here, via Moneyfacts, is the chart that launched a thousand takes:

It’s underpinned by this gilt yield chart (yoinked from explainer here):

Which is underpinned by this chart of Bank of England rate expectations:

Which is underpinn—hopefully you get it.

The danger is that a chunk of Britons who locked in ultra-low-interest-rate mortgages a few years ago are now facing a massive increase in their repayment costs. Economists say the burden of this, because homebuyers are more leveraged than in the past, and because the shifts are proportionately larger, will be bigger than under the double-figure interest rate mortgage regimes of the past.

Analysis by the Resolution Foundation think-tank says this could costs thousands of pounds extra for households:

Annual repayments are now on track to be £15.7 billion a year higher by 2026 compared with prior to the Bank’s rate tightening cycle starting in December 2021 – up from a projected £12 billion increase at the time of the most recent Monetary Policy Report in early May. Annual repayments for those remortgaging next year are set to rise by £2,900 on average – up from £2,000.

There are basically two imperatives at work here, one economic, one political:

— A spike in mortgage rates will lead households to cut spending, resulting in repayment delinquencies and repossessions
— A spike in mortgage rates will cause homeowners, many of whom like the Conservative party, to like the Conservative party less

There’s an obvious a tension between those two factors. A version of the former is exactly what the Bank of England wants as it tries to cool the economy, as Capital Economics writes:

Our own forecast is that rates will need to rise to a peak of 5.25%, rather than to 5.75%, to weaken the economy enough to reduce wage growth and core inflation to levels consistent with the 2.0% inflation target. But the risk is that the labour market remains resilient and interest rates need to rise further. Either way, the further rise in mortgage rates this week is a necessary part of the process.

Whereas the latter — if the Tories are tempted into offering some kind of relief — could easily metastasise into an inflation-stoking policy (nb current UK leadership does not have an unblemished record on smart policy).

Though direct support has been ruled out by Chancellor Jeremy Hunt, Citi’s Benjamin Nabarro says additional private support now seems likely:

The government can exert considerable pressure on the banks here via threats on: 1) taxation or 2) reserve remuneration. With more homes owned outright, the main impact would likely be to slow transmission from interest burdens to house prices. With more homes owned outright, that may prove significant. The risk of mission creep is also significant. Fundamentally, any attenuation of monetary policy transmission risks a worse trade off for monetary policy…

[Any] intervention here would put the UK on a dangerous path. By pushing back the house price correction in particular, this would add to the risk in our view of a further 25bps hike in September, as well as cuts only later in 2024.

What’s to be done?

Morgan Stanley reckons the rise in bank rate isn’t even that important, given the backdrop of falling prices elsewhere. In her preview of Thursday’s Monetary Policy Committee decision, economist Bruna Skarica writes:

Bank Rate at 5%+ is less of a financial stability headache this year than in 4Q22, when a potential spike in mortgage payments came alongside a likely surge in utility bills too, implying, at one point, non-discretionary spending at unmanageable levels for a relatively large share of mortgagors.

MS reckons households utility bills are likely to be about £500 per year lower at the end of this year than last. Skarica, cont.:

[Mortgage] rates at these levels are painful – but not an acute financial stability risk . . . two-thirds of the outstanding mortgage debt is held by 30% of top income earners (they account for ~45% of all mortgage holders, and take out bigger mortgages). They have attained, on average, ~7% pay growth at the start of 2023. With mortgage rates at 6%, 90% of that improvement now has to be allocated to higher mortgage payments this year – compared to ~65% prior to the recent repricing in Bank Rate expectations. This is challenging even without taking into account increases in food prices, council tax, water and broadband bills. But repayment issues are only likely to arise for the bottom 20% of income earners with a mortgage, who account for 10% of households with mortgages, and for less than 5% of all outstanding mortgage debt. Long story short, the economy muddles through, the housing market takes a hit – especially with the squeeze in the buy-to-let market boosting supply – but financial stability risks look manageable . . .

The recently floated media reports about some chance of MIRAS (mortgage interest relief) returning are another example of fiscal and monetary policy potentially working in the opposite direction.

This is the brutal base case at the moment: the poorest households get crushed, but that’s the price you pay to slow the economy down. It’s Farquaad economics — but those homeowners should have fully educated themselves on epidemiology, quantitative easing and global supply chains before they dared expose themselves to rate risk.

It potentially misses some nuance, however. After all, pay more or don’t pay aren’t necessarily the only options available to borrowers reaching the end of their mortgage terms. As Pantheon Macroeconomics’ Samuel Tombs notes:

. . . many borrowers also are lengthening the term of their mortgage when they refinance in order to limit the jump in monthly payments.

Tombs has taken a deep dive into the Mortgage Lending and Administration Return data released by the Bank of England and the Financial Conduct Authority. [extremely clickbait voice] What he found will SHOCK you:

Regular mortgage repayments have been remarkably stable. They equalled £5.0B in April, up only £304M, or 6.5%, on a year earlier and £424M from the end of 2021. The proportion of all households’ nominal disposable income absorbed by regular repayments has remained steady at 3.7%. This stability is surprising, given that the effective interest rate on the stock of mortgages rose to 2.76% in April, from 2.05% a year ago and a low of 2.01% in December 2021, when the MPC began to raise Bank Rate. Monthly regular repayments would have risen by £860M since December 2021, if households had simply rolled over their mortgages and accepted the higher repayments entailed by the rise in rates…

In theory, households also could have switched to interest-only mortgages in order to mitigate the hit to their incomes when they refinance. But the Mortgage Lending and Administration Return shows that the proportion of new mortgages either fully or partially interest-only has declined to 19.2% in Q1—the lowest since records begin in 2007—from 23.2% a year ago.

The MLAR data also show that missed repayments have risen only marginally, with mortgages in arrears accounting for only 3.9% of total loan balances in Q1, up from 2.8% in Q4 2021. Regular repayments in April were 8% lower than they would have been, if they had risen in line with the effective mortgage rate and nothing else had changed, so the rise in arrears can only explain a small fraction of persistently low repayments. By process of elimination, then, we can conclude that the only way households have kept their repayments down is by lengthening their mortgage terms when they refinance.

Here are the charts:

This entire dynamic is underpinned by demographic shifts. The average first-time borrower, in 2021, was 36 years old and took out a 27-year loan: ergo, many people expect to be working and paying off their mortgage deep into their 60s. Tombs:

Virtually all lenders now are willing to lend for 35-year terms and on the basis of repayments extending until someone is 75 years old, with some, such as Nationwide, willing to lend until the borrower is 85 years old.

Accordingly, we still think that the blow to households’ incomes from mortgage refinancing will not be large enough to drive the economy into a recession, especially when the pressure on households’ incomes from higher energy prices is about to fade.

If we are entering a period of structurally higher rates, this shift — to a preponderance that housing analyst Neal Hudson has called ‘ultra-marathon’ mortgages — could rapidly accelerate. Hudson highlighted the major problems this could cause in an April FT piece. Extract:

Ultimately, the economic picture over the life of these 35-year-plus mortgages will be a major factor in whether first-time buyers have to run the full length of their mortgage terms — but the recent trajectory is far from reassuring. Hopefully, economic growth returns and wage growth continues. If they don’t, then we’re probably facing a more extreme version of the pre-pandemic housing market. Fewer moves, younger households stuck in homes that are too small, older households under-occupying family homes and a torrid time for all the parts of the economy dependent on turnover in the housing market.

It’s a grim outlook, but looks increasingly inevitable for many households, who face a choice between multi-decade mortgages or handing their keys over to the bank.

Given the latter option probably involves (re)entering even-more-FUBAR rental market, the choice seems pretty obvious. And as for the economic situation: oh well.

Source: Economy - ft.com