Inflation is currently elevated, especially for essentials such as energy and food. To curb inflation, the Monetary Policy Committee has been raising Bank Rate, which means that many households will face higher borrowing costs on their mortgage.
Higher mortgage rates and rising costs of living make it harder for mortgagors to afford their mortgage repayments. This could cause some households to default, or cut back sharply on their spending, posing a risk to financial stability.
We assess this risk by calculating the share of households in the UK with high mortgage debt burdens, measured by cost of living-adjusted mortgage debt-servicing ratios (COLA-DSRs).
COLA-DSRs are constructed by dividing a household’s debt repayments by their income, adjusted for taxes and costs of essentials. COLA-DSRs above 70% are considered high, as households with COLA-DSRs above 70% are more likely to default or cut back sharply on spending.
The share of households with high mortgage debt burdens has increased over 2022 H2 (Chart A). The share is projected to increase further over 2023 to 2.4%, or around 670,000 households, approaching levels comparable to the start of the global financial crisis.
Chart A: Historical and projected share of households with high COLA-DSRs, decomposed by drivers (a) (b) (c) (d)
Footnotes
- Sources: British Household Panel Survey/Understanding Society (BHPS/US), Bank of England, NMG Consulting survey, ONS and Bank calculations.
- (a) The left-hand side of this chart was published as Chart 2.1 in the December 2022 Financial Stability Report.
- (b) The impact of inflation is estimated by assuming the increase in prices of essentials is consistent with the November 2022 Monetary Policy Report projections and the extended Energy Price Guarantee, and households do not substitute away from this essential spending.
- (c) Interest rate projections are based on market expectations for Bank Rate as at 25 November 2022.
- (d) Information about the Government’s Cost of Living Payments can be found at GOV.UK.
Higher mortgage rates and inflation are the largest drivers of the projected increase in the share of households with high mortgage debt burdens. Around four million households will be exposed to rate rises over 2023. This number includes those on variable rates and those coming to the end of fixed-rate products during this period.
The majority of the inflation impact is due to high energy and food price inflation. Food and energy account for around half of households’ essential spending. Inflation for both of these has been higher than for most other essentials over 2022 and inflationary pressures are expected to remain strong over 2023.
Unemployment is expected to increase over 2023, which will also make it harder for some households to repay their mortgage.
In contrast, higher nominal wages and government support measures, including the Energy Price Guarantee and Cost of Living Payments are expected to have a mitigating effect. Nevertheless, the share of UK households who could struggle to afford their mortgage payments is expected to increase over 2023.
The FPC judges that UK banks are strong enough to support households through this challenging period for households and the wider economy. See the December 2022 Financial Stability Report for more information.
This post was prepared with the help of Eleanor Fielding, Elspeth Hughes, Nuri Khayal, Marek Rojicek and James Waddell.
This analysis was presented to the Financial Policy Committee in 2022 Q4.
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