CML news & views

The UK economy finally nudged into the black in the final quarter of 2009, but that was preceded by 18 months of recession – so an extended period of rising mortgage arrears and possessions was widely expected. Nonetheless, when we reported our most recent data on arrears and possessions last week, the numbers were more encouraging than many commentators, including ourselves, had originally anticipated. 

Our initial forecast – admittedly made at a time of much greater uncertainty about economic recovery and before the cycle of sharp reductions in interest rates in 2008/09 had been completed – was that there would be 75,000 mortgage possessions in 2009. That proved pessimistic and we subsequently revised it downward last summer, when we said we expected 65,000 possessions in 2009 and that 360,000 mortgages would end the year in arrears of at least 2.5% of the outstanding balance.

However, last week’s data showed a better outcome than even this revised forecast, with 46,000 properties taken into possession in 2009, and 188,300 loans finishing the year in arrears of 2.5% or more of the outstanding mortgage balance. That meant that the number of cases of arrears at the year-end was lower than at the end of the third quarter, although it was 3% higher than a year earlier.

While we cannot be complacent about arrears and possessions at current levels, there is some good news in that numbers are being kept in check by a combination of persistent low interest rates, lender forbearance and a range of government initiatives to provide help. Even last year’s unexpected rise in house prices has been helpful, in some cases helping to offset the erosion of equity for borrowers in arrears.

It is important to stress that payment problems are not directly linked to negative equity. Nonetheless, we estimate that the number of borrowers currently in negative equity (the vast majority of whom will be paying their mortgage in full and on time every month) has fallen to 650,000, compared with around 900,000 in April last year.

Mortgage problems and the recession

Payment problems usually lag a recession, which initially triggers higher unemployment and then feeds through into an increase in mortgage payment problems. But this typical pattern has not been such a clear feature of the recent economic downturn.

During the current cycle, mortgage arrears and possessions began to edge upwards some years before the onset of the recession. Following a long period of economic growth, and low and stable interest rates, mortgage arrears and possessions had fallen to exceptionally low levels in 2003 and 2004, even though the UK economy continued to grow at an annual rate of between 2% and 3% up to 2007. 

When the recent economic downturn began, we saw the number of possessions accelerate – as we would expect – from 25,900 in 2007 to 40,000 in 2008. Despite our expectations, however, growth in the number of possessions then slowed in 2009, as our data has shown.

Interest rates

Low interest rates are clearly helping to keep arrears and possessions in check.

Looking more closely at our statistics on mortgage arrears, we can also see that the number of households with lower levels of payment difficulty has actually fallen recently, while the number with more serious arrears problems has remained broadly unchanged. 

This suggests that the rapid decline in interest rates – and the persistence of the Bank of England’s base rate at its record low level of 0.5% for almost a year now – is helping some borrowers with modest difficulties to get back on their feet. Low interest rates are also helping more households cope with temporary financial difficulty without falling into arrears.

Some of those with more serious problems, meanwhile, are able because of low interest at least to stabilise their arrears, even if they cannot recover them. Where borrowers are able to do this, lender forbearance may be helping to keep them in their homes.

Unemployment has also not grown as sharply as expected during the recession, and that is also helping to keep the growth of payment problems in check. Lenders’ arrears management policies are also helping borrowers in difficulty, along with a range of government assistance schemes. 

What happened in the past…

Generally, borrowers falling behind with their mortgage commitments in the current downturn appear to have found it somewhat easier to manage those circumstances than was possible a generation ago, when we last saw a period of significant economic disruption and growing mortgage payment problems. 

In 1991, with more than a million fewer mortgages than we have today, possessions peaked at 75,500 – significantly higher than we have seen in the current downturn. Back then, however, interest rate movements were much less helpful for borrowers in difficulty – in 1991, for example, the Bank of England base rate hovered between 10% and 14%.  

After possessions peaked in 1991, it took some years before the combination of a slowly improving economy, lower interest rates and an end to falling house prices brought about a significant reduction in the number of borrowers in difficulty. It was only in 1996, for example, that the annual number of possessions (at 42,600) fell below the level we have today. 

Looking back, however, we can now see that the mid-1990s also marked the beginning of what eventually proved to be a strong recovery in the housing market. From the mid 1990s until 2004, a combination of low and stable interest rates, a benign economic backdrop and strong house price growth brought arrears and possessions to their lowest levels since the 1980s.

…and what might happen in the future

The pattern of the early 1990s – in which the annual number of possessions exceeded 40,000 for seven consecutive years up to 1996 – suggests that we should only expect a slow recovery from the peak of mortgage payment problems in this cycle. What we may see is something of a ‘bulge’ in possessions, extending over a number of years, rather than a ‘spike’ with totals rising sharply and falling rapidly.

Such a pattern would be consistent with our forecasts for 2010. Our prediction is that both arrears and possessions are likely to continue to rise modestly this year – from 188,000 to 205,000, and from 46,000 to 53,000, respectively. 

Even at this stage, however, it is possible that these numbers look a little pessimistic, although the economic and political outlook remains uncertain. We must also bear in mind that, even if economic recovery progresses broadly as expected, the path towards a stronger housing market may not be a smooth one.

Payment problems

One of the key determinants of the number of possessions – and the shape and speed of a housing market recovery – will be future movements in interest rates. As we have already seen, rates at current levels are helping borrowers in arrears to manage more effectively. And because low rates mean that a borrower’s outstanding debt grows more slowly – and is capable of being paid off more quickly if his income increases – they can extend the period for which a lender is able to show forbearance.

But while low interest rates give more breathing space to borrowers and lenders, it is important to understand that extending forbearance is no guarantee that a borrower will succeed in getting back on track. In those circumstances, lender forbearance may only delay possession, and possibly leave the borrower with higher arrears.

Other factors affecting the outlook for arrears and possessions include future movements in house prices and progress towards wider economic recovery. But despite last year’s unexpected upturn in property prices, the housing market remains weak, and future movements in prices are uncertain.

Progress towards economic recovery is also unpredictable. But a strengthening economy will improve employment prospects, and therefore have a bearing both on the number of borrowers falling into arrears and on their ability to find a new job quickly enough to recover their position.

Conclusion

There are still upward pressures on mortgage arrears and possessions, but they are not as strong as we originally anticipated. Low interest rates, the ability of lenders to extend forbearance and a range of different government initiatives are all helping to provide more helpful circumstances for borrowers in difficulty than was possible in the last recession. 

It is, however, likely that the number of borrowers affected by arrears and possessions will only subside slowly. Interest rate movements and progress towards economic recovery will play a crucial role in shaping the final outcome.