Shocks From Resetting UK Mortgages “Relatively Severe”
Payments shocks associated with the resetting of a large number of UK mortgage loans in the coming months are likely to be “relatively severe,” especially in the nonconforming sector, Standard & Poors says in a new report.
For the UK mortgage market as a whole an estimated 2 million loans are due to reset by the end of 2008, equivalent to approximately 17% of all mortgages outstanding, S&P says in Payment Shock Approaching For Borrowers In U.K. Nonconforming RMBS.
Looking at the U.K. nonconforming loans backing the RMBS transactions that we rate, we estimate that around £9 billion of fixed-rate loans are scheduled to reset by the end of 2008, representing 23% of total balances outstanding. A particularly large volume of resets—nearly £5 billion—look set to occur during the first half of 2008.
UK mortgage borrowers are coming under increasing strain from rising interest rates. Five hikes in the Bank of England base rate since last summer would have been testing enough. But recent events in financial markets has meant an even sharper increase in wholesale funding costs for lenders, who are passing those costs on to borrowers in the mortgage rates they offer, S&P says.
Borrowers with floating-rate loans have already seen their monthly mortgage payments rise as a result. However, the majority of UK mortgage lending currently takes the form of short-term fixed-rate loans, which only reset to a floating rate after two or three years. This could prove a concern for many borrowers who took out fixed-rate loans between late 2005 and late 2006: most of these are due to reset to significantly higher rates over the next 12-18 months, giving rise to a sudden “payment shock” for many borrowers.
A number of coinciding factors mean the likely scale of this upcoming effect—and the potential subsequent impact on borrowers’ payment behavior—is relatively severe by recent standards. The pace of rate rises means payment jumps will be larger. Slowing house price appreciation and tightening lending standards could give borrowers fewer refinancing options. Recent increases in the uptake of fixed-rate loans also mean the effect will be more widespread.
Assuming current market conditions persist, we think that even borrowers who are able to refinance will suffer an average increase of 26% in their monthly payments. For those unable to refinance, the shock could be significantly more severe.
Although the risk of payment shock is considered in our RMBS rating analysis, realization of that risk could still have an impact on transactions, increasing the likelihood of reserve fund draws, for example. The precise effect on outstanding ratings will depend on many macroeconomic and transaction-specific factors. We will, as always, monitor closely the evolution of these factors and their influence on RMBS ratings, S&P concludes.
The full report can be purchased here.
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