Better times are coming for UK mortgage holders

Open Editor's Digest for free

Rula Khalaf, editor of the Financial Times, picks her favorite stories in this weekly newsletter.

Relief is coming for UK mortgage holders. But not, like, a lot of it.

A Barclays note published today outlines a “positive consumption drive” on the horizon, as holders of flexible mortgages (minority-of-minority) and people with shorter fixed-term mortgages (minority-of-minority) start to feel that it's nice, nice interest rate easing:

We wrote about mortgages a bit last summer, looking at how the shift in the composition of UK home borrowing to fixed (mainly five-year) terms has shifted the dynamics of monetary policy transmission from a 'wave of rising interest rates gently hitting all ships “to 'f**' *you specifically for ships built in 2017-18.”

Some things haven't changed. To shamelessly reuse the meme:

(We'd love to talk about renting more. The problem from the Markets & Finance Blog's point of view is that mortgage market dynamics depend on quantifiable metrics, whereas the UK rental market is more like a prisoner's dilemma where one prisoner is forbidden from speaking. )

How have other things developed since then? They've both changed a lot and not much either. Thanks to Rishi Sunak's tireless efforts, the UK was able to beat inflation. . .

. . . And Andrew Bailey is now a national hero:

However, growth remains an issue. Is an imminent interest rate hike the magic solution needed? Not really, says Abbas Khan of Barclays.

Khan points out that the problem is fundamentally the dominance of reform for five years. Combined with the short window when prices peaked recently, this means that price relief – like price pain – will pass slowly. In the meantime, rest means less pain:

The vast majority (85%) of mortgage debt is fixed-rate, usually for two or five years. This has not always been the case: the proportion of variable-rate debt has fallen sharply over the past decade, from a peak of nearly 70% in 2012. Rate changes take longer to reach holders of fixed-rate debt, which will limit the overall increase. In consumption during the cutting cycle.

Even at a base 200 basis point downgrade cycle, households with five-year fixed-rate mortgages (about half of total mortgage debt) that refinance over the next two years are likely to experience an increase in mortgage payments because they have closed Interest rates before the latest rate hike cycle (although this would not be the case if rates fell quickly below levels seen at the start of the pandemic…

Meanwhile, households with two-year fixed rate mortgages are also more likely to refinance at higher rates until 2024 even during the bank rate cut. However, those who refinance through 2025 should eventually be able to refinance at lower rates (i.e. with lower mortgage payments) since their current rates were well locked into the hiking cycle. Hence, mortgage refinancing is likely to become an income boost for this group by 2025…

Accordingly, even at our baseline for interest rates and taking into account the pass-through of reductions on variable rate debt, the overall impetus from mortgage refinancing on aggregate consumption is likely to be close to zero for both 2024 and 2025.

We have reversed the order of the chart pairs to maintain the tone:

Barclays' credit team points out that this rather small payment could benefit “grocers, pubs, gyms”, whoever.

Even more interesting is Khan's analysis of the counterfactual: a world in which the UK never developed a passion for fixed interest rates. As a reminder, let's recycle the (slightly dusty) chart from Toby's article last June on how mortgage composition has shifted over the long term:

Comparing the actual share of variable rate mortgages with the last surge in 2012 (when about 70 per cent of mortgages were floating), Khan envisions a bigger recovery after a much worse downturn:

What can we learn from this? One view is that the UK was lucky: the mortgage market of 2012-2013 would not have been able to survive the post-pandemic interest rate cycle anywhere near as smoothly as the mortgage market did in 2022-2023.

However, a potential blind spot in Khan's analysis is the apparent reliance on slightly outdated mortgage data. The Barclays chart (Figure 4 above) continues until the end of 2022. But the latest data from the Bank of England suggests that this was roughly the point at which behavior changed, and a much larger number of mortgage borrowers are leaning towards short-term fixed rates:

Look at this stress on the 5 year old! Assuming that Barclays used slightly older data, this suggests that the mid-term income boost may be more advanced than the bank expects.

(Update: Khan has reached out to FTAV to clarify that the most recent data was used for the analysis, with the selection of dates in Figure 4 designed to show the long-term shift.)

In the longer term, it will be interesting to see whether this group – the hapless victims of the transmission of monetary policy through the modern mortgage market – changes their behavior.

If so, it may be difficult to predict how it will change. Let's imagine a woman named Sarah (which Google suggests is one of the most popular names in the 1980s) in her mid-30s:

— In early 2018, Sarah purchased a home with a five-year fixed-rate mortgage at a very low rate.
– In early 2023, Sarah has to renew her mortgage, and finds that interest rates have increased dramatically. You read the Financial Times, and you know that interest rates will likely fall in the not too distant future. Instead of getting a new five-year fix, you get a two-year fix.
– In early 2025, she renewed her mortgage again. She is being offered an interest rate that is lower than her mortgage for 2023, but still much higher than her original rate in 2018.

What happens next? Will the bittersweet anniversary of 2023 prompt Sarah to take out a longer-term fixed mortgage (say 10 years) for a greater period of stability at lower rates? Would you bet that interest rates will fall further and you get another two years? Do you accept the new normal of higher interest rates and a return to 5-year defaults?

We certainly hope you're not expecting us to get the answer, but it will be interesting to see what Sarah's family does in the UK.