Mortgage affordability is set to worsen in the coming years, as borrowers in the UK fix on higher interest rates than those at origination, analysis from a credit rating agency found.
An analysis from Moody’s suggested that this weakened mortgage affordability would particularly impact buy-to-let and “non-conforming residential borrowers”.
The firm predicted that 55% of owner-occupied mortgages and 62% of buy-to-let portfolios backing the residential mortgage-backed securities (RMBS) it rated were expected to switch from fixed to floating rates before 2026, when rates were set to fall but still be higher than pre-2023.
It said while many borrowers who took out a mortgage before 2023 would be able to refinance and keep mortgage prepayment – or early repayment – rates high, the default risk would increase among borrowers who were unable to refinance.
Moody’s said this would impact the performance of RMBS. If lenders continue to allow borrowers to switch rates without undergoing an affordability assessment, the transition to higher interest rates would make them “financially stretched” and further impact the performance of future RMBS transactions, the firm suggested.
The performance of non-conforming and buy-to-let RMBS transactions would be compromised by the refinancing “high quality borrowers” who would take out a new rate in the next two years.
Moody’s said the level of collateral prepayment volumes – the number of mortgages that exit securitised portfolios through prepayment – had gone up as borrowers refinanced onto a different product at a lower interest rate. The firm said it was seeing this happen across more securitisations of buy-to-let and non-conforming mortgages, and suggested this behaviour would continue until 2026.
It said this would leave borrowers who were unable to refinance at favourable rates, increasing the exposure of RMBS to potentially weaker borrowers. Moody’s said this was a concern for buy-to-let portfolios because of the more concentrated risks.
Specialist lenders to have more ‘underwater’ borrowers
Moody’s said borrowers with “highly volatile incomes” and “weak credit profiles”, typically served by specialist lenders, were “particularly vulnerable to lower mortgage affordability”.
Additionally, loans originated by specialist lenders would have more affordability risks over the next two years because of the characteristically higher rates.
According to its analysis, specialist lenders are set to have a larger share of borrowers who are “underwater” than high street banks. Moody’s said the share of underwater borrowers would peak at the end of this year, with affordability starting to improve in early 2025 before weakening again in 2026.
Non-conforming loans originated between 2010 and 2019 have the greatest risk of being underwater, due to higher floating rates. In the Moody’s data sample, it found the median interest rate among non-conforming loans was 12.8%, higher than the rate of 5.6% across all owner-occupied loans.
However, it said arrears levels of underwater loans would be low because of the availability of additional financial reserves, income streams or borrowers prioritising mortgage payments over other commitments.
It found that recent loans were more exposed to being underwater because their mortgage rates were inflated, and borrowers have not “registered the income increases received by borrowers with more seasoned loans”.
Buy-to-let loans originated between 2019 and 2021 will see affordability decline in the next two years, but rising rents and a further decline in rates may ease the financial pressure on landlords. Moody’s said landlords who took out a loan could be particularly advantaged by these improvements, as a large proportion of loans are linked to floating rates.
Olga Gekht, senior vice president at Moody’s Ratings, said: “Even though UK interest rates have recently dropped, borrowers still face high refinancing risks as for many of them, their fixed rate mortgages will expire in the next two years. This will make mortgages less affordable over time. Borrowers with unstable incomes and poor credit profiles, often served by specialist lenders, are especially at risk.
“As the strongest borrowers actively refinance, the concentration of weaker borrowers in loan pools grows, worsening the impact on residential mortgage-backed securities, particularly in buy-to-let and nonconforming transactions.”
Shekina is the deputy editor at Mortgage Solutions and commercial editor at Mortgage Solutions and Specialist Lending Solutions. She has nearly eight years of experience in the B2B publishing market, having previously covered the hospitality, retail, pet, accounting and jewellery sectors.
Shekina has worked for Mortgage Solutions and Specialist Lending Solutions for almost five years. Here, she covers the market’s breaking news stories, engages with professionals in the sector, and oversees any commercially agreed content in partnership with mortgage-related companies.
This includes presenting webinars and hosting roundtable discussions on developing themes in the mortgage sector.
She is an NCTJ-trained journalist and was nominated for the Headline Money Awards Mortgage Journalist of the Year in 2021.
In her spare time, Shekina likes to read, travel, listen to music and socialise with friends.
She currently reports on current events in the mortgage market and liaises with financial clients to produce sponsored content.
Follow her on Twitter at @ShekinaMS
