A recent report produced by the Resolution Foundation highlights the problems which may ensure in vulnerable households when interest rates start to rise.
With signs of a reasonable sustainable economic recovery attention is now turning to the process of weaning consumers and borrowers off low interest rates without causing a crises.
Despite Mark Carney, Bank of England governor’s insistence that expectations of an imminent increase are premature, financial experts still expect that if recovery continues at its present pace, interest rate rises will be inevitable.
The Bank of England has a clear dilemma: how to maintain the low cost of borrowing long enough that the recovery is not choked off, while still containing inflation at or below target levels.
Although the number of households falling behind with their debt repayments has remained relatively low since the crises in 2008, it is predicted that this will change dramatically as interest rates start to rise. Millions of British households will still be servicing very high levels of debt as the proportion of their repayments to income increases.
The Resolution Foundation project identified around 3.6 million ‘debt loaded’ households, who spend more than one-quarter of their income on repayments. They estimate that, if rates increase to 5 per cent by 2018 (an adverse case but thought to be possible) the number of households spending more than half of their disposable income on repaying debt could rise to around 2 million.
Even if interest rates were to rise more slowly that predictions, and income rises were to outperform current projections, the number in ‘debt peril’, as the Foundation terms it, would still rise considerably.
The report highlights the fears of an unbalanced recovery where economic growth does not translate into broad-based increases in incomes, but is highly dependent on the domestic consumer, who’s spending accounts for around two-thirds of GDP.
If a rise in the cost of borrowing leaves many struggling, and this could include private investors with high loan to value ratios, then this burden of debt will inevitably put the sustainability of economic recovery at risk
Resolution Report Key Findings:
– Even under ‘good’ income growth, the number of households with perilous levels of debt rises from 600,000 in 2011 to 1.1 million in 2018. With sharper increases in borrowing costs, the number rises to 1.4 million and 1.7 million exceeding both its pre-crisis peak and the level set in the early-1990s recession.
– If the squeeze on household incomes continues, the number in debt peril reaches1.4 million, 1.7 million and 2 million under each of the interest rate rises. Our ‘worst case scenario’ implies a tripling in the number of affected families from 2011, equating to one in every 14 households.
– Those in the poorest 20 per cent are much more likely to be in ‘debt peril’. The percentage of ‘debt peril’ households in the bottom quintile rises from 5 per cent in2011 to as high as 9 per cent under our worst case scenario.
– Yet a large proportion of lower income households have no debt. Perhaps most startlingly, if we focus just on those households in the bottom quintile who do Have debt, the proportion in ‘debt peril’ jumps to as high as 27 per cent under a good growth scenario and to 28 per cent in our worst case scenario.
The key findings of this report show the potential for a payments crisis as interest rates rise and GDP growth does not follow a pattern of broad-based household income growth.
This will not only impact on landlords rental debts, they will also be squeezed at the other end on their own debt repayment increases.
Landlords should be thinking ahead now and doing some stress testing on their borrowing: what happens to their finical position if interest rates rise to 1, 2, 3, 4, or 5% over the next 5 years and if they lose rental income from 10, 20 or even 30% of their portfolio?
Producing Cash-Flow forecasts for each of these scenarios is the simplest way to head off trouble: by forecasting your future income and expenditure over a period of time given these possibilities, you can make plans to avoid trouble well in advance.
Resolution Foundation Report – Closer to the edge? Debt repayments in 2018 under different household income and borrowing cost scenarios