Base rate rise could push half a million into arrears

An increase in Bank Base Rate to 2.5% could push nearly half a million mortgage borrowers into arrears, according to the Bank of England.

Its latest quarterly bulletin looks at the impact that of higher interest rate rises on the nation's borrowers. And it warns that should Base Rate rise to 2.5%, the number of vulnerable households – those most at risk of falling behind on their mortgage payments – would jump from 360,000 to 480,000.

Keeping debt low

That said, there is some positive news from the Bank of England. One of the things it looks at, to see how homes would cope with interest rate rises, is the debt-servicing ratio. This is basically how your debt repayments measure up against your household's gross income. The higher the ratio, the more of your income is taken up by paying off debt, and therefore the more vulnerable you are should interest rates rise. According to the Bank of England, once you pass 40% of your income going towards your debt, that's when arrears become more likely.

And the Bank of England is keen to stress that the number of households with high mortgage debt-servicing ratios is relatively low compared to its average level since 1991.

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A question of income

The study, carried out with NMG Consulting, found that the average outstanding mortgage stands at around £83,000, while those with unsecured debt owe an average of £8,000.

The average income before tax stands at around £33,000, jumping to £43,000 for those with mortgages.

And it's income that is the big factor here. Exactly how vulnerable a household will be when Base Rate begins to rise all comes down to how their income changes. And the bulletin states: "There is a risk that the most vulnerable households will experience lower-than-average income growth as rates rise." So if wage growth continues to be anaemic, then more homes will be in trouble if rates rise.

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Cutting back spending

The NMG survey looked at how interest rate rises would affect the way households spend their money. Around 37% said they would need to take some kind of action if interest rates rose to 2.5% and their income did not change, which is actually lower than the same survey last year.

However, when they were told exactly how their mortgage repayments would change with a two percentage point increase, the number who said they would need to take action jumped to a whopping 60%.

Interestingly, homes with the highest levels of debt compared to income did not appear more likely to say they would cut spending than other mortgagors. As the Bank of England points out, this may be because "those households may still be adjusting to past income shocks, and so will not have scope to cut spending further when rates rise". In other words, there are a number of households whose finances are already at breaking point, even with Bank Base Rate having sat at the record low of 0.5% for more than five years.

Will Base Rate rise to 2.5%?

Of course, it's highly unlikely that Base Rate will hit 2.5% any time soon. The improving economic situation and low level of inflation have pushed expectations of a first Base Rate rise back to the latter half of 2015. And even when it does increase, it is most likely to do so slowly.

Nonetheless, reports like this from the Bank of England should serve as a stark reminder that there is a decent chunk of households in the UK that are still struggling to get by. And the key to them getting through any future Base Rate rises is for improved levels of income growth.

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