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Defaults set to rise as higher living costs pressure household finances

Paloma Kubiak
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Paloma Kubiak

There could be an increase in defaults over the coming months as rising interest rates and living costs push households to the brink, the Bank of England (BoE) has warned.

Struggling families may need to make “sharp, and difficult, cuts to their spending,” this year, said Dame Colette Bowe, an external member of the Bank’s Financial Policy Committee (FPC).

Low-income households are likely to feel the tougher economic conditions most, she added.

Rising energy prices have darkened the forecast for the UK economy, with GDP slowing and a recession looming.

This means the “outlook is even more challenging for UK households”, Dame Bowe said.

She underlined that the total stock of UK household debt (excluding student loans) is high by historical standard at just under £2trn in Q1 2022, equivalent to around 124.5% of total household income.

However, this is below a 2008 peak of 146%.

The share of households struggling is set to remain lower than the financial crisis, Dame Bowe predicted.

The FPC member also said it is “worth reminding” that unsustainably high mortgage debt has historically affected financial stability as highly indebted households face challenges from income cuts or rates increasing. And where lenders experience losses where highly indebted households face repayment difficulties.

A test of borrower resilience

In a speech, Dame Bowe said the FPC was aware of ‘minority’ concerns around the withdrawal of the mortgage affordability stress test last month.

But she added that underwriting standards over recent years have improved the resilience of mortgage borrowers, while loan to income limits and regulator rules mean households don’t take on unaffordable levels of mortgage debt.

She said: “We are conscious that the rise in living costs and interest rates will put increased pressure on the finances of UK households in the coming months, with lower-income households in particular finding it difficult to adjust their spending behaviour in response to the rise in prices.

“This will test the degree of borrower resilience in the system as borrowers struggle with bills or [to] manage their other spending commitments.”

The FPC will continue to measure household debt and resilience closely as the weaker outlook weighs, Dame Bowe said.

Assess affordability accordingly

Robin Fieth, chief executive of the Building Societies Association, said: “As highlighted by Dame Colette Bowe, the current rise in living costs and interest rates will put increasing pressure on UK household finances in the coming months, with some borrowers likely to struggle with bills and other spending commitments.

“Lenders provide tailored support to those who are struggling and will continue to do so. It is important that anyone struggling to pay their mortgage gets in touch with their lenders as early as possible, the earlier you start talking to each other the more likely it is that a solution can be found.”

He added: “The recent removal of the FPC’s affordability test was a welcome simplification of the regulatory framework which will reduce administration for mortgage lenders over time. Lenders must still assess affordability carefully and in line with expectations for interest rates, as required by FCA rules, and there will be no free for all.”