Payment shock will not lead to arrears surge, says S&P

Fears that a rise in interest rates soon will cause a spike in arrears may have been overblown, says Standard & Poor’s.

A study from S&P’s Ratings Services published today claims that even rate rises of up to 4% over the next year should have a minimum effect on most borrowers.

Based on a sample of 500,000 loans S&P estimated the likely change in monthly payments would have with rate rises ranging from zero to 4% over the course of 2010.

The ratings agency assumed rate rises would be applied equally to discount floating rate products and SVRs and assumed that borrowers defaulted from the end of a teaser rate to the lender’s SVR.

About 40% of mortgages in the pool were interest-only and half were already on SVRs as at the end of 2009.

S&P says any rate rises this year will have a minimal impact on arrears as recent lending criteria has been strict and low interest rates have not given way to lending at greater loan-to-income ratios.

The ratings agency says a second reason why forthcoming rate rises may not lead to arrears is that many outstanding loans in the sample were underwritten before the sharp decline in rates, meaning rate rises will simply borrowers start paying the higher rates they were at the start of the loan.

Andrew South, credit analyst at S&P, is also confident the employment situation will improve which will stabilise arrears.

He says: “We believe that UK unemployment rate has probably peaked, even though the economic recovery will likely be slow to take hold. So on balance we feel there is little significant further upside risk for arrears among UK mortgage loans in the near-term.”

S&P predicts that if rates were to rise by 2% by the end of this year then payments in its sample would rise by an average of £80, equivalent to around 32% of the existing monthly payment.

But borrowers on trackers would be hit with a rise in monthly payments of £215, or around 112% of the current payment, though S&P points out that this large increase is relative to the low tracker rates available at the end of last year.

For repayment mortgages a rate rise of 2% would mean an increase in monthly payments by £47, while interest-only borrowers would see their payments go up by £152.