The Council of Mortgage Lenders (CML) today reported a rise in the number of mortgages more than three months in arrears from 167,000 in September to 219,000 in December. As a proportion of the 11.7 million outstanding mortgages, this represents an increase from 1.42% to 1.87%.
In its December forecast, the CML projected a further rapid rise in over three months arrears cases during 2009, to 500,000 or 4.4% of outstanding mortgages by year-end. The Bank of England, in its October Financial Stability Report, has also suggested that the arrears proportion would reach 4.4% in a “severe” economic scenario.
The recent and projected large rise mainly reflects the impact of the recession on homeowner incomes. Other factors include: a lack of refinancing options for those facing payment difficulties, especially given house price falls; government efforts to reduce repossessions, implying that more borrowers remain in arrears; and the arithmetic impact of lower interest rates on the calculated number of missed payments.*
How does current and prospective arrears performance compare with the housing downturn of the early 1990s? The CML series on over three months arrears begins in 1995 but earlier figures exist for cases more than six months overdue. The statistical relationship between the two series can be used to “backcast” the three months plus arrears proportion for earlier years – see first chart.
Three points are notable. First, arrears performance was worse at the comparable stage of the last recession. GDP had fallen for two quarters by the end of 2008, when 1.87% of mortgages were three months or more in arrears. In December 1990, also after two quarters of GDP contraction, the estimated proportion – based on the backcast – was 3.2%.
Secondly, the over three months arrears proportion is estimated to have reached 6.3% in the early 1990s, well above the 4.4% level projected by the CML and Bank of England (although the CML may expect a further increase in 2010).
Thirdly, arrears peaked in December 1992, five quarters after the trough in GDP and around the same time as unemployment. Even assuming an economic recovery from late 2009, this suggests that the arrears proportion will remain on an upward trend until late 2010, or even beyond.
The key reason for expecting arrears performance to be less bad than in the early 1990s is a much lower level of income gearing. Household interest payments as a proportion of disposable income peaked at 11.9% in the third quarter of 1990 but reached only 7.9% at the top of the recent interest rate cycle and should fall to 4% or lower as a result of rate cuts – second chart.
*To explain this effect, consider a borrower whose monthly payment obligation falls from £800 to £200 because of lower interest rates. An unchanged arrears amount of £800 rises from the equivalent of one month’s payment to four, resulting in the mortgage being included in the three months plus total.