What the Government might actually do to tackle the Mortgage Crunch

Today’s thirteenth interest rate rise in succession is a lot more than unlucky for mortgagors. And for Rishi Sunak. There’s a lot of mortgage pain coming, and much of it will arrive during the run-up to a 2024 election – current market pricing implies that households remortgaging in that election year are set for an annual mortgage bill rise of around £3,000 or more on average.

Unsurprisingly then attention has turned to what the Government should do about it: the Lib Dems want £3 billion spent on emergency mortgage protection, Michael Gove hinted such help is being kept “under review”, and others want to see a return to tax relief for mortgage interest payments. But back in the real world, very widely available subsidies for households to pay their mortgage bills simply isn’t going to happen – as the Chancellor has now spelt out. It’s worth setting out why that is and, more constructively, what policy options will actually be on the table in Whitehall.

There are bog standard policy reasons the Chancellor has ruled out major support for everyone seeing mortgages rise – like the £15-20 billion price tag of covering the increase in mortgage bills (only slightly less than what the Government spent on energy support last year) and the fact that it would overwhelmingly benefit higher-income households (three-quarters of the help would go to the richest 40 per cent) at a time when those on lower incomes are struggling with surging food prices and rents.

But then there’s a more specific reason: Bank of England Independence. The point of making the central bank independent in the late 1990s was to allow monetary policy to focus on the economic rather than political cycle – or, more specifically, on the judgement of the right level of interest rates to achieve the two per cent inflation target.

This creates a philosophical and policy problem for those proposing that the Government cover mortgage bills. The former is that having fiscal policy step in to protect households from the impact of monetary policy trying to slow the economy down is certainly a challenge to central bank independence (governments, of course, always influence the transmission of monetary policy – but doing so in response to rate rises would least).

The policy problem is the binding one, though. If the Government prevents interest rate rises having as big an effect on slowing the economy as expected, what does the Bank of England do? Raise interest rates even further. I don’t think that’s what the Government wants, not least because it significantly increases the Government’s own borrowing costs: adding 1 percentage point to rates raises borrowing by around £20 billion. And remember: the existing rise in debt-interest costs is already crashing into Conservative plans for pre-election tax cuts (and Labour plans for investment in green or net zero) with higher rate expectations since the Spring Budget in March giving the Government its own £15-20 billion headache.

So, ignore the talk of broad mortgage support, which isn’t going to happen. History here in the UK and abroad tells us where the real focus will be: pressure on lenders to treat borrowers in distress well, with Government support for those in temporary difficulties or on low incomes. Longer-term reforms to the mortgage market should also be considered – including longer-term fixed-rate mortgages – but will do nothing for those struggling today.

The Chancellor is planning a summit with mortgage lenders this week to discuss what more they can do to help struggling borrowers, with the Shadow Chancellor getting in early today with calls for banks to allow borrowers to switch to interest-only or longer-term mortgages. Such flexibilities (especially term extensions) are likely to take some of the strain in the months ahead (a household remortgaging with a £200,000 loan at 6 per cent can cut their monthly payment by a nearly £250 a month if they move from a 20- to 30-year mortgage). But we need to be clear that this defers the pain of higher interest rates, rather than removing it, and understand lenders are largely already doing these things. The reason that the changes being suggested by campaigners (including those reasonable ones from Martin Lewis) are relatively minor is exactly because mortgage-lender practices have changed drastically already since the very-high rates of repossessions seen during the 1990s.

At the point of issuing mortgages, the key changes happened back in 2014, heavily limiting interest-only mortgages and introducing more stringent affordability checks (and those who opposed, or indeed watered down, those changes now look very silly indeed). And the approach when borrowers get into difficulty has softened from the financial crisis, as lenders have recognised they are expected to offer far more forbearance – including with mortgage holidays – and repossess a property only as the last resort. We saw around 2.5 million mortgage holidays taken during the pandemic. Repossession numbers are likely to rise materially in the months ahead thanks to higher interest rates, but from a very low level by historic standards.

What might see larger increases in repossessions, and banks less willing to offer forbearance? Combining these higher interest rates with a recession, and specifically rising unemployment, which some now believe the Bank of England will need to create. That’s why in the weeks ahead the Government, and the Labour Party, won’t get away with calling on other people to do things, and I’d anticipate a Government announcement on more targeted help for homeowners in distress.

This is most likely to come via the – currently little discussed or, indeed, used – Support for Mortgage Interest (SMI) scheme – just as it did the last time repossessions were rising, during the financial crisis. This provides a loan to help cover mortgage interest payments that a homeowner can’t afford, with that loan repaid when you sell the property. The scheme is targeted towards those on lower incomes, specifically those in receipt of a means-tested benefit (Universal Credit and the legacy benefits it is replacing, and Pension Credit).

In 2010-11, the peak of the financial crisis, just over 240,000 families were receiving SMI, but it has been little claimed in recent years, partly because few mortgagors get into trouble in normal times, but also because of a key change to the scheme: before April 2018 it provided a payment to cover interest payments, with the move to the loans being part of George Osborne’s benefit cuts after the 2015 election. Take-up has been so low the Government actually commissioned research investigating the reasons why no-one wanted to claim it (which were fairly obvious: people don’t like extra loans when they’re already struggling to pay one off).

The Chancellor tweaked SMI last Autumn to enable more homeowners to benefit from it as pressures on household budgets increased, shortening the waiting period before someone on Universal Credit can access support from nine to three months, and removing the zero earnings rule so poorer working households are covered. But the impact was expected to be small: official forecasts (before recent rate rises) expected SMI to cost the Government a grand total of £1m a year in the next few years, rather than the £0.2 billion a year in its final pre-loan years.

So what are the options that Treasury officials will be presenting the Chancellor with to go further, with temporary or permanent reforms of SMI? They will include:

• Increasing the maximum amount of any mortgage on which interest support can be claimed from the current £200,000, which hasn’t risen in over a decade. Around 13 per cent of mortgagors have outstanding mortgages bigger than that cap, according to the Wealth and Assets Survey.
• Rapidly updating the interest rate used to calculate the amount of SMI households get (it’s currently 2.65 per cent vs the 6 per cent some households are now facing).
• Further reducing the waiting time before those moving onto Universal Credit are eligible for SMI from three months.
• And the big one: reversing George Osborne’s conversion of SMI into a loan so that those being supported simply have some of their mortgage interest bill paid by DWP. During the financial crisis, the Government spent just over £2 billion (in today’s prices) over three years doing just that.

A package covering these types of policy shifts, not blanket subsidies or tax relief, is where the policy action will be. It will be particularly important if interest rate rises do spark a material rise in unemployment. The outlook for the UK economy is particularly uncertain right now – but politicians should be doing more than calling in bankers for meetings. Now is the time to prepare not just for higher interest rates, but the consequences of them.