The UK mortgage market is among the most exposed globally to rising interest rates due to borrowers relatively high debt-to-income ratios, the expected path of sterling interest rates and the number of loans with two-year fixed rate periods in the UK.
In Fitch’s recent report, Global Mortgage Markets Ranked by Vulnerability to Rising Rates, the agency ranked markets based on how vulnerable they would be on average, to a 3 percentage point increase in mortgage rates by end-2023 while income was kept unchanged.
Fitch found that borrowers in Australia, the UK and Spain would, on average, experience the most significant payment shocks in Fitch’s scenario out of the 10 countries reviewed, measured by the relative increase in the stressed versus original debt-to-income. These countries ranked the highest mainly due to the high proportions of variable rate loans originated in the reference period of 2020 (including those that will reset in the next 24 months).
However, in Spain the share of fixed-rate originated mortgages versus floating has moved to 73% versus 27% floating as of March 2022 compared to 48% fixed versus 52% floating as of December 2020.
Having said that, Fitch Ratings expects UK and Spanish mortgage performance to remain robust even though households are facing significant cost pressures in particular for energy and transport. The current strength of the labour markets should limit deterioration in mortgage performance for most borrowers in both countries, but borrowers with lower incomes and higher leverage and legacy non-conforming borrowers may underperform.
In the UK, borrowers coming to the end of five-year fixed rate periods most likely had no interest rate stress performed at underwriting, in line with FCA guidelines. Payment increases, although not factored in to the underwriting decision, are likely to have been offset to a material extent by nominal wage growth over this period.
UK and Spanish mortgage performance remained resilient throughout the Covid-19 pandemic’s effects in 2021, despite expectations of deterioration, when measured by arrears and foreclosures.
Fitch anticipates Bank of England policy interest rate to increase to 2% by end-2022 and to 2.5% by end-2023. We forecast UK home price growth to slow to 1% to 3% a year (down from almost 11% in 2021). We expect the ECB policy rate to reach 1% by end-2022 and 1.5% by end 2023, and in Spain, we expect a modest nominal house price growth for the coming quarters considering the relatively low wage growth of recent years. Fitch expects new mortgage lending in Spain to concentrate on fixed-interest rate loans, as borrowers anticipate interest rate rises in the near term as inflation risk intensifies.
Adding to the headwinds is the fact that falling mortgage rates has been one of the drivers of the European home price growth over the past decade, but this has begun to change. Rising mortgage interest rates combined with limited scope to materially extend repayment term or loan to value are likely to weaken housing affordability for borrowers seeking new loans.
The Netherlands and Italy are two countries that should be less exposed to rising interest rates, because of the dominance of mortgages with lengthy fixed-rate period. In 2020, over 80% of mortgage in both countries were originated with fixed rates of longer than two years.
Looking at home price forecasts, in the Netherlands we expect home price inflation to slow to 8% to 10% in 2022, down from 21% in 2021. Affordability for home purchases will also be constrained by a rapid rise in cost of living and rising interest rates, while regulations targeting buy-to-let investors could negatively affect house price growth.
Stretched borrowing capacity will somewhat counterbalance the Dutch housing supply shortage that in combination with low interest rates, reduced stamp duty and pandemic-induced personal savings had buoyed house prices in 2021. T.fore, while the shortage of available properties will continue to place upward pressure on house prices in the near future, price gains are likely to decelerate from last year’s peak.
In Italy, mortgage performance may be affected by the implications of inflation challenges and supply shocks in the next 12 to 24 months. However, we do not expect substantial performance deterioration on housing mortgage loans given the prime nature of the collateral and resilient labour markets.
We forecast low-single-digit home price growth in Italy in 2022, supported by heightened demand and limited supply, largely consisting of dated properties. Housing demand is also driven by changes in housing preferences, with some shift towards suburban areas and larger homes, but cost of living concerns and worse consumer confidence due to the war in Ukraine may curb demand. Price growth was 0.5% in 2021 after a few years of stagnant prices.
Globally, Fitch expects home prices in 2022 to continue growing in many key markets, but at a more moderate pace than in 2021. Rising interest rates and costs of living will constrain affordability especially for first-time buyers.
Alessandro Pighi is EMEA head of RMBS at Fitch Ratings