8th May 2013
Borrowers have failed to use the unprecedented low interest rate environment to pay down their mortgage loans, says the Council of Mortgage Lenders in a paper it has issued to consider what happens when interest rates rise.
The trade body says there has been a marked decline in borrowers withdrawing more equity from their homes though that may be as a result of the fall in the number of housing transactions.
The note says: “In theory, lower rates create the potential for borrowers to pay down their debts more quickly, but there is little evidence that this has happened to any significant extent. There has been a marked decline in housing equity withdrawal but this is largely because of a fall in the numbers of housing transactions and borrowers remortgaging. Falling house prices have also eroded the potential to withdraw equity, and households are more likely than they were four years ago to view their housing wealth as a buffer against economic hardship rather than as a means of funding spending.”
The CML suggests that policymakers are aware that big rises in interest rates have serious implications for borrowers.
“When the Bank eventually raises the official rate, it is also likely to do so slowly. Policymakers are alert to the potential impact of higher rates on household finances, and the Bank has said that it will approach this in steps that can easily be reversed if necessary,” it says.
The trade body adds: “The onset of an era of exceptionally low interest rates was associated with a significant decline in equity withdrawal – but not as a result of households, in aggregate, conspicuously paying down debt. The significant changes are lower levels of house purchase activity, less remortgaging and, as a result, less capital withdrawal.
The CML says the trend has been reinforced in recent years by the decline in the number of new interest-only mortgages. “The fact that most lending is now advanced on a repayment basis reinforces the steady repayment of capital through monthly mortgage payments”, it adds.
Considering the impact of a rise in interest rates, the CML says: “A higher Bank rate – associated with higher lender funding costs – will affect the ability of borrowers to service debt. But the speed and circumstances in which the Bank rate rises will be crucial in determining the outcome.
It says that policymakers are aware that many households will only be able to manage slow and modest increases in borrowing costs. In his evidence to the Treasury select committee earlier this year, the incoming governor of the Bank of England, Mark Carney, said: “To ensure the monetary policy committee retains adequate room to respond to the developments in economic conditions, it will be sensible for any tightening in monetary conditions to come about first through an increase in Bank rate that could, if necessary, be reversed easily.”
The note adds: “Most commentators agree that we are unlikely to see any tightening of policy until economic recovery is well established and some growth in incomes has been restored. What we have seen in the aftermath of the financial crisis is that that borrowers in aggregate tend to prioritise mortgage debt even when their real incomes fall. We would expect this to continue once the Bank rate begins to edge slowly upwards again in the coming years.”