Rise in interest rates means nearly a million households could be debt prisoners

July 25, 2014

By Lucy Palmer-Richeson

25.07.2014

A rise in interest rates has the potential to make 800,000 families ‘mortgage prisoners’, according to a new report.

The report by the Resolution Foundation warned that double the number of households could have problems with repaying debts in the coming four years, even with a “relatively benign” increase such as the proposed 3pc.

It predicted that the number of mortgage holders currently spending more than 30% of their income on repayments could increase to 2.3 million by 2018, compared with1.1 million now.

It also predicted that by 2018, the number of households in the severest financial situations, where over half their income is spent on repayments, could increase to 1.1 million, compared with a current 600,000.

The Bank of England’s base rate has been at a historic low of just 0.5pc for the last five years. However, Bank of England governor Mark Carney warned this week that, “The UK economy is starting to head back to normal. As the economy normalises, Bank Rate will need to start to rise.”

The Resolution Foundation suggested that the Bank of England held off on Bank rate rises until there was evidence that this was a sustainable action.

According to Matthew Whittaker, chief economist at the Resolution Foundation, “It would be a serious mistake to think that the legacy of problem debt built up in the pre-crisis years will simply evaporate with a return to economic growth.

“The magnitude of the stock of debt is simply too large, given expectations that income growth will be gradual at best.

“And while the mortgage market largely remains competitive, tighter lending criteria means that some highly-stretched borrowers face limited choices. There is a pressing need for regulation to respond to this new context.”

The Resolution Foundation, which campaigns to improve living standards of those on low and middle incomes, warned that the country needs ‘shaking from its complacency’ and lenders should be increasing efforts to aid households who would be worst affected by a rise in interest rates.

Mr Carney insisted that any rises in interest rates will be ‘gradual and limited’ to make it easier for the most indebted borrowers. His fear was that if rates rise more quickly it could ‘tip the economy into recession’.

“It is the prospects for household indebtedness that concern us,” he said.

“History shows that the British people do everything they can to pay their mortgages. That means cutting back deeply on expenditures when the unexpected happens.

“If a lot of people are highly indebted, that could tip the economy into recession. Since we start from a vulnerable position we need to be especially careful.”