Expert warns of cheap home loan 'fool's paradise'

Homeowners who believe they may have weathered the recession storm may be sucked still further into a financial quagmire, experts have warned today.

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According to one financial expert, millions of UK households, who are currently coping thanks to low interest rates, could face financial oblivion when rates rise.

Economist Danny Gabay, a former Bank of England expert, warned that "zombie households" in which families have taken out loans well beyond their means are heading for disaster when rates inevitably increase.

Financial experts across the board have echoed Mr Gabay's comments with one claiming that many British householders are "living in a fool's paradise", according to the Daily Mail.

Recent figures from the Council of Mortgage Lenders suggest that almost three million could run into financial difficulties if interest rates rise by two per cent.

Even as interest rates stand, almost 1.3 million homeowners are only just managing to keep up mortgage payments that swallow more than 35 per cent of their take-home income.

Mr Gabay said: "It is an extraordinary position to be in. Fixing government finances is important but is only part of the problem. The other, larger part, is fixing household finances, where in fact the crisis began.

"It is very politically convenient to believe that the crisis was caused by greedy bankers but nobody made people take out mortgages of five times their income. Lots and lots of people borrowed too much."

Though most agree that rates cannot continue at their current level, the Bank of England is not expecting to raise them for at least another year.

But Mr Gabay's paper, published yesterday, suggested that the current rates mean many banks are avoiding the potentially bad loans already on their books and urged the Government to set up a "bad bank" to buy up the troublesome mortgages.

"We are in a situation that I am very worried about. Too much money has been lent against assets which have fallen in value but those losses have not yet been fully recognised. We are being kept alive on a near-zero interest rate drip and we can't move forward."

Are you a homeowner worried about coping when interest rates rise? And do you agree the banks should tackle the problem of bad loans? Leave your comments below...