The Bank of England (BoE) has warned that extending mortgage terms and switching to interest-only could heighten debt burdens in the long term.
According to the BoE’s Financial Policy Committee (FPC) report, the “full impact of higher interest rates” had not yet passed through to all household and business borrowers.
It continued that the average cost of mortgage payments would rise as mortgage deals are renewed, noting that the proportion of income spent on mortgage payments was expected to rise this year and next year.
The FPC said that this was “likely” to be below the peak seen before the Global Financial Crisis in 2007.
The number of homeowners behind in meeting mortgage payments has “risen modestly” but “remains low by historical standards”.
The report noted that some mortgage borrowers had extended their mortgage term and a “small number” had moved to interest-only deals.
It warned that while this “eases pressures for these households in the short term, it could result in higher debt burdens in the future”.
High debt servicing households increasing
The FPC continued that the share of households with “high debt servicing ratios”, which was partially attributed to the higher cost of living, was growing and this was expected to continue through next year.
The report said that this level would stay below the high seen in 2007 due to mortgage market measures introduced in 2014 such as the loan to income cap and the FCA’s responsible lending requirements.
It noted that owner-occupier arrears are low in “historical terms” but there had been a “modest increase”.
The FPC said that mortgage term extensions and switching to interest-only will be “bound by FCA responsible lending rules requiring lenders to take account of future changes to income and expenditure, such as the borrower retiring, where that is expected to happen during the mortgage term”.
Buy-to-let landlords under pressure
On the buy-to-let side, the report said that borrowers were experiencing increases in mortgage interest payments along with “structural factors likely to put pressure on incomes from residential property”.
“This could lead some landlords to sell, putting downward pressure on house prices, although net sales by landlords have not been significant so far. Buy-to-let landlords may seek to continue to pass on higher costs to renters, adding to other cost-of-living pressures,” it added.
The FPC said that there was some evidence that households were upping the use of consumer credit in response to the cost-of-living pressures and higher debt servicing costs.
It noted that this could lead to “greater debt vulnerability for households in the near-term”.
“A significant rise in unemployment would increase the likelihood of UK household debt vulnerabilities crystallising. UK unemployment remains low by historical standards at 4.3%, although employment indicators are generally softening with subdued economic activity,” the FPC said.
The FPC continued that UK banks were in a “strong position to support customers who are facing payment difficulties”.
