The UK’s Mortgage Timebomb: The Good, The Bad and The Very Ugly

Article by Melissa Croxford

Following a persistently high inflation rate, the Bank of England has recently increased interest rates.  Whilst this is an established method for helping to reduce inflation as it discourages overall spending, rising interest rates have worrying effects on the UK’s housing market.  Interest rates were raised first to 4% and now to 5.25%: the highest the rate has been since 2008.  Some have forecasted that this may rise to 6% or even 7% by the end of the year.  As interest rates soar, banks’ lending money to homeowners and commercial property owners will, in turn, increase their mortgage rates.  It is a cause of concern as it is during an already persistent cost-of-living crisis, so property owners may be even more strapped for cash as they will be paying more for their mortgages than previously once the time comes for them to re-mortgage, or in obtaining a mortgage in the first place.  The concerns about the effects of high-interest rates are reflected in the change in the UK’s housing market, as in 2011, 70% of mortgage holders were on floating rates compared to just above 10% today.

First-Time Buyers  

The impact of rising interest rates may be most pronounced for first-time buyers, as their options have been significantly reduced.  Recently, lenders such as Santander and HSBC have pulled new borrower deals, with the overall number of mortgage products being cut by 40% for first-time buyers.  The myriad of lenders doing this restricts the options for first-time buyers, suggesting that the mortgage timebomb is worsening potential homebuyers’ ability to get on the property ladder: something which was already a challenge.  This is particularly prevalent for those with a small deposit, as data provider Moneyfacts indicates that there were 199 mortgage products available for hopeful buyers with a 5% deposit versus 347 this time last year.  Largely, this is because lenders are concerned about granting mortgages to first-time buyers with smaller deposits as there are more risks.  First-time buyers have a greater chance of going into negative equity if interest rates continue to increase and affect their ability to pay their mortgage.  Thus, there is more of a risk of the house going into negative equity as the homeowners had limited capital, to begin with.

As there are fewer options for first-time buyers, long-term mortgages are increasingly being entered. Loans of 35 years are becoming increasingly common, with some even entering a 40-year loan period for their mortgages, compared to the typical period of 25 years.  This means that those agreeing to these long-term loan periods will have smaller monthly instalments but spread across a longer period.  In March of this year, 19% of all loans taken out by first-time buyers were for 35 years or longer.  Seemingly, first-time buyers are prioritising reducing their short-term financial outgoings during the current economic downturn, so that they can get on the property ladder.  However, as the average age of first-time homeowners is now 32 according to research by Halifax, the repercussions of these longer loan terms mean that first-time buyers following this route will spend most of their lives paying back their mortgage, longer than previous generations.

Furthermore, there have been suggestions by those in government, such as Michael Gove, that the UK should adopt a 25-year fixed-rate mortgage like other countries, including the United States.  Whilst this would protect homeowners from fluctuating rates, it has the adverse effect of confining homeowners to the present higher rates or a longer period, as well as restricting someone’s ability to re-mortgage their home as they will be subject to an early repayment charge to evade the fixed rate charges.  Thus, whilst the option may seem more appealing for first-time buyers now to enter the housing market, it may have significant repercussions in future.

It is not just those looking to buy a house for the first time that this mortgage crisis is affecting, as it also has a detrimental impact on those who are not ready to buy presently but wish to in the future.  The rental market has been stretched as concerns over the impact of rising interest rates on mortgages have caused landlords to evaluate their buy-to-let properties.  It is estimated that around 225,000 landlords will face refinancing losses meaning many are choosing to either sell their property or increase rent.  This is primarily because lenders such as NatWest have increased rates affecting buy-to-let deals as mortgages for these deals rose from 6.21% to 6.3% in the space of three days, with the expectation that this will continue to rise.  The effects of this are clear on the rental market as Zoopla recently estimated that rent is now at the highest it has been in a decade, with it being 10.4% higher than last year.  Increases in the rental market are having a detrimental effect on potential future homebuyers’ ability to raise capital for a deposit, as their money is going towards rent more so than ever before.  Thus, the number of first-time buyers is likely to see a drop in the next few years.

Existing Homeowners

It is not just first-time buyers that are hit by the interest rate hikes: people already on the property ladder are similarly being affected when it comes to the value of their properties and re-mortgaging their homes.  Increasingly, two- and five-year fixed-rate mortgages at rates of around 6% are being obtained by homeowners when it comes to re-mortgaging their homes.  This is predominately because many homeowners hope that rates will decline when it comes to re-mortgaging their homes again following the crisis. Therefore, they are hoping to wait out the mortgage pitfall over the next few years.  However, this will likely affect their disposable income as analysis by Fiscal Studies indicates that 1.4 million mortgage holders will face a 20% hit to their disposable income because of the hike in rates.  Furthermore, Public First consultancy suggests some households will have to pay over £5,000 more on mortgages following the rate rises.  During an already prevalent cost-of-living crisis, the impact rate rises will have on people is a serious cause for concern and will become more pronounced over time.  However, there is evidence that repossessions of households – if homeowners fail to keep up with mortgage rates – is unlikely as the low-interest rates and stability of the economy over the past decade before recent crises have led there to higher levels of equity in homes.  Following the 2008 economic crash, there have also been tighter lending conditions for mortgages, meaning overall repossession seems unlikely.

However, that is not to say that homeowners will not struggle.  Increasingly, housing prices have declined, with the Nationwide Building Society producing statistics indicating average house prices are 3.8% lower than last year.  There is a danger here that homeowners could be going into negative equity as the value of their homes declines.  Furthermore, recent Zoopla findings suggest homeowners, because they are concerned over high-interest rates, are accepting lower offers, such as 42% of sellers in June of this year agreeing to a deduction of 5%, which is the highest level since 2018.  This further ties into a negative outlook for homeowners as it demonstrates that changes to mortgages are affecting all levels of the property ladder including those who own property and not just first-time buyers.

Impact on Law Firms

The recent developments mean that there are several potential impacts on law firms.  First, Real Estate departments may see a downturn in the number of individuals able to take out a mortgage.  This is already pronounced with current first-time buyers but will also be a trend likely to continue as renters struggle to gather a deposit together since their money is now increasingly going towards rent.  However, there may be a few opportunities for real estate lawyers as their expertise will be likely required to deal with mortgage disputes and advise clients, both commercial and residential, about the legal aspects of refinancing their mortgage. Second, there may be several prospects for Insolvency and Restructuring Law as high-interest rates may mean businesses and individuals struggle to repay debts and maintain the costs of loans, so run the risk of insolvency.  This may be seen more where commercial properties struggle with the recent mortgage rate hikes.  Third, there may be a continued downturn for Merges and Acquisitions (M&A) as high-interest rates affect businesses’ ability to borrow money for M&A deals meaning companies may be unwilling to take on the risk of debt.  Finally, there will likely be lots of opportunities for lawyers in Banking and Finance as several new clauses and agreements will need to be amended following recent trends.

The impact of increased interest rates proves to have some worrying consequences.  However, it is not a completely negative outlook for the future.  Recently, UK lenders have passed annualised stress tests which look at their ability to handle matters in the event of a severe economic downturn.  One of the indicators for this test was interest rates reaching 6%.  Therefore, if predictions of increased interest rates do materialise, there is hope that whilst the housing market will be stretched, it will not collapse.