The UK is facing the twin threats of soaring inflation and higher taxes, which may make it harder for some potential mortgage borrowers to get their application accepted.
This affordability squeeze has been brewing for months with rising inflation and the planned end to Covid-19 support schemes looming.
However, it hit a crescendo in September with the news that National Insurance Contributions (NICs) would rise next April to fund the National Health Service (NHS) and social care, and with the dramatic increase in energy bills that will see many households pay hundreds of pounds a year more for gas and electricity.
Any big leap in energy prices also brings the possibility that interest rates could rise to keep living costs in check.
Brokers to whom Mortgage Strategy spoke did not predict a sudden surge of home loan rejections but they warned there could be problems for some borrowers as lenders reserved the right to tweak their criteria or limit the amount offered on borderline cases.
People could be left high and dry when the furlough scheme comes to an end
This is not a new issue as living costs have risen steadily throughout the year. The most recent Consumer Prices Index showed a 3.2% year-on-year increase in August, up from 2% in July. That represented the biggest jump in the annual figure since 2012 and was well above the Bank of England’s 2% target.
Upward forces
Although many analysts pointed out that some of the increase was due to comparisons with a period in 2020 when the Eat Out to Help Out restaurant discount scheme was in operation, there are plenty of other upward forces on costs. In the six months prior to August, UK prices rose by 2.7%, much of which has been attributed to increases in the cost of food, transport and recreation. For example, petrol prices reached their highest level in eight years over the summer.
To make matters worse, the Bank expects inflation to increase to 4% by the end of 2021, although economists are divided on whether rising costs will become a significant problem in the long term.
Some of the predictions of short-term inflation spikes are a result of the dramatic jump in energy prices. The regulated price cap for standard tariffs increased on 1 October by £140 on average, based on typical use. Most suppliers set their standard tariff — the energy equivalent of a standard variable mortgage and paid by 11 million households — at the price cap rate.
Rocketing utility costs could have a bearing on maximum borrowing levels
Prices jumped due to the soaring cost paid by suppliers because supply has failed to keep up with post-lockdown rising demand. However, last month the supply crisis intensified, leading every supplier to withdraw promotional tariffs. This will force almost all customers onto the expensive standard rate when their introductory fix ends — if they are not on it already.
With wholesale costs still rising, some analysts expect regulator Ofgem to announce another cap increase in April, of about £200 a year, putting further pressure on household budgets.
Health and social care levy
While that is still speculation, what is certain is that, from April, all employees and the self-employed who pay NI will pay 1.25 percentage points more.
From April 2023, the extra tax will instead become a separate Health and Social Care levy and technically will not be added to NICs. At that point it will also be paid by state pensioners who are still in employment, who do not pay NI currently.
Credit scoring and online affordability assessments are a mystic art
The hike will cost an employee on £30,000 a year an additional £255 annually, rising to £505 at £50,000 and £1,130 at £100,000. The government expects the move to generate £12bn a year, which will go to the NHS initially and then into the social care system.
Peak Mortgages and Protection managing director Rhys Schofield says: “There are so many storm clouds, such as utility bills going through the roof, which are going to hit household budgets hard.”
Borderline clients
This squeeze will become an important topic between brokers and clients given it may have a big impact on affordability, particularly for those on the border between acceptance and rejection.
London & Country associate director David Hollingworth does not expect a mass rejection crisis, partly because existing lender models account for rising prices. However, he says lenders may adjust their criteria to take into account the changing economic climate, which could create problems for some borrowers.
Hollingworth says: “The concept of affordability is rooted in ensuring the mortgage is affordable not only at the outset but also in the longer run. It takes into account commitments such as utilities, and therefore rocketing costs could have a bearing on maximum borrowing levels as higher amounts feed in to the calculation.
There are so many storm clouds that will hit household budgets hard
“The affordability models should mean the market is well placed to adapt to changes in costs. That doesn’t mean lenders won’t adjust their attitude to risk, though, and they would be able to pull back or tighten their criteria if they felt it necessary.”
Other brokers too do not predict a Doomsday scenario but they anticipate problems for certain clients, particularly when lenders assess how much they are prepared to advance.
Cherry Mortgage & Finance director Matthew Fleming-Duffy says: “There could be more rejections. As basic costs such as energy, food and taxes increase, a potential borrower’s ability to evidence suitable affordability decreases. While this does not necessarily mean cases will be declined, it reduces an individual’s borrowing capability and may make their desired purchase unfeasible.
“Credit scoring and online affordability assessments are a mystic art, and the results can be intensely variable. Lenders amend their algorithms as and when they see fit, so we may see it become tougher for certain individuals to pass through these systems if the scoring becomes tighter.”
A natural question many will ask in the face of rising inflation is whether the Bank of England will raise the base rate from its lowest level of 0.1% to try to keep prices under control. Its Monetary Policy Committee (MPC) voted unanimously to maintain the 0.1% rate at its latest meeting last month.
Mortgage rates have been a good-news story for many consumers
Analyst firm Pantheon Macroeconomics’ chief economist, Samuel Tombs, points to markets suggesting there could be two sets of rate rises in the next year, albeit he seems surprised by that view.
Tombs explains: “The MPC did its best to say absolutely nothing of note in the minutes of its September meeting. It wants to wait for labour market data post furlough and the Budget, and yet rate expectations are up again, apparently.”
Hargreaves Lansdown personal finance analyst Sarah Coles adds: “Higher inflation could persist and persuade the Bank of England to revisit interest rates sooner rather than later next year, which would mean buyers face higher mortgage payments, which in turn could hit the market.”
Reduced income
The other tsunami looming for some borrowers is reduced income after the planned end of the furlough scheme and the Self-Employment Income Support Scheme last month. This could lead to numerous business failures and rising unemployment where employers could not afford to keep paying staff without government support.
Further tax increases seem likely, making financial planning more important than ever
Pantheon Macroeconomics estimates that, of the 1.6 million people on furlough before the scheme ended, about 170,000 will be made redundant, 190,000 will find a new job and 120,000 will leave the workforce. It also expects about 900,000 to return to their employer on full pay and 225,000 on reduced pay. If correct, that would leave more than 500,000 people either without work or on lower pay.
Research from Hargreaves Lansdown in June found more than half of consumers were concerned their income would fall as the pandemic continued to unfold.
Coles says: “Hundreds of thousands of people could be left high and dry when the furlough scheme comes to an end, and those carrying debts could find themselves in serious difficulty.”
Support for Mortgage Interest
Meanwhile, following the end of furlough, trade bodies UK Finance and the Building Societies Association (BSA) are calling for the government to reduce the wait to claim money via the Support for Mortgage Interest (SMI) scheme, from 39 weeks to 13 weeks. They also want Westminster to allow people on Universal Credit (UC) to claim SMI if they are working reduced hours.
To be eligible for SMI, borrowers must currently receive benefits such as Jobseeker’s Allowance or UC. However, as people move from the former benefit to the latter, they are no longer eligible to claim SMI if they receive any income from employment. Hence the two bodies are calling for eligibility to include those working up to 16 hours a week.
Lenders amend their algorithms as and when they see fit
BSA head of mortgage and housing policy Paul Broadhead says: “With the end of furlough, it is likely unemployment will rise. Without urgent modification of the SMI scheme, the risk of home repossession could become a reality for many.”
The Money Advice Trust charity supports this call. Its director of external affairs and partnerships, Jane Tully, says: “Mortgage borrowers caught at the sharp end of the impact of Covid need the government to act now by reducing the wait for SMI to 13 weeks, and by changing the earnings rules under UC to ensure they can access the vital support they need.”
Future tax rises
Although that is an issue for today, a key threat in future is that of more tax rises. It has been claimed in some quarters that huge government spending on income support schemes and other pandemic-related outgoings could lead to further hikes, with some suggesting capitals gains tax is next in the government’s sights. Research by Barclays Wealth found a third of adults felt unprepared for post-pandemic tax rises.
Barclays Wealth head of wealth planning Anthony Ward says: “As the UK battles with increasing national debt due to the pandemic, further tax increases seem likely, making financial planning more important than ever.”
Undoubtedly the affordability squeeze over the coming months will put pressure on some households’ budgets — but current market conditions favour other clients.
Without urgent modification of the SMI scheme, the risk of home repossession could become a reality
Although the cost of living is rising, the cost of borrowing has plummeted in 2021, with lenders bringing out record-low mortgage rates. This means anyone who fixes now will be locking in at ultra-low rates, possibly for many years, which will provide protection in case interest rates rise during their introductory term.
Hollingworth says: “Mortgage rates have been a good-news story for many consumers and, with other costs rising, being able to lock in the most significant outgoing at a low rate offers real benefits.
“For some time, borrowers have largely been opting to fix, which should help give some resilience to monthly budgets in the face of rising costs.”
While some borrowers, therefore, may be cheering, it remains to be seen how much the affordability squeeze will affect the less fortunate end of the market.
