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Huge Threat Posed By Interest Rate Rises

26th June 2013

Serious personal debt problems have been in decline according to recent official insolvency statistics (which include protected trust deeds and sequestrations in Scotland). In a climate of financial concern banks have been less willing to lend and consumers generally less enthusiastic to borrow. Many homeowners are benefiting from extremely low mortgage interest rates that have helped to offset a general stagnation in earnings.

The Bank of England has now turned its mind to what will happen when mortgage rates increase in the future. They wanted to understand the threat posed to consumers and financial institutions should millions of households suddenly face increased mortgage costs. The results of their analysis don’t make for comfortable reading.

They believe that a rise of just 1% in interest rates would force homeowners representing 9% of total UK mortgage debt to take action. Such actions might include cutting costs or finding ways to increase their income. If mortgage interest rates were to rise by 2% households representing 20% of UK mortgage debt might have to take similar actions.

It’s clear that many people simply won’t be able to increase their income or reduce their expenditure sufficiently. Jobs are in high demand, wages are suppressed and inflation remains stubbornly high frustrating efforts to cut back on household spending.

Accordingly there is likely to be a huge financial squeeze on Scottish homeowners when the rate rises arrive. Those that are struggling to manage existing debts may find it impossible to carry on. Others may find that they borrow to maintain their lifestyle in the absence of opportunities to earn more or cut costs. The outcome is likely to be an increase in the number of people in Scotland utilising insolvency measures such as trust deeds and sequestrations or facing the threat of their home being repossessed.

When will interest rates rise? Nobody knows the answer for sure, but the consensus among City economists seems to be that rates will increase in around two years. The outgoing Governor of the Bank of England has indicated his belief that it will be a long time before interest rates go up.

The potential for significant mortgage defaults also causes concern for the wider financial system. It’s uncertain whether some banks are sufficiently robust financially to withstand a significant volume of mortgages falling into arrears.

The Bank of England has asked the Financial Conduct Authority and the Prudential Regulation Authority to further investigate the financial threat that an increase in interest rates will pose to consumers and financial institutions. Their reports are due in the autumn. 

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