Bankruptcy fears as interest rates are set to rise

Luke Graham, special to CNBC

The number of people filing for bankruptcy in the U.S. and U.K. has been falling steadily for the past few years, but charities and analysts are concerned that homeowners could get in trouble if the U.S. Federal Reserve and the Bank of England raise interest rates.

The latest figures from the U.K. government, released in July, showed the rate of bankruptcies (measured as the number of insolvencies per 10,000 adults) has fallen every year from a peak of 30.9 in 2009 to 21.8 in 2014.

Meanwhile, in the U.S., the number of people filing for bankruptcy declined by 12 percent to 879,736 for the year ending June 30, according to records released by the U.S. bankruptcy courts.

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Analysts have welcomed these figures. Herman Poon, director in Fitch Ratings, said in a press release last week: "Further improvements in both jobless claims and unemployment helped precipitate the better-than-expected decline in consumer bankruptcy filings. If this momentum continues, personal bankruptcy filings will fall for a fifth straight year once 2015 comes to a close."

However, both Mark Carney, governor of the Bank of England, and Janet Yellen, chair of the Federal Reserve, have hinted in the past few months at future interest rates rises as their countries' economies improve.

However, one of the implications of higher interest rates is that some households could be pushed into arrears – and possibly bankruptcy.

"Historically low interest rates over the past six years have made it easier for people to manage their finances," said Gillian Guy, chief executive of U.K. charity Citizens Advice, in a press statement. "A rise in rates will make things harder for those already struggling, and push those who are just about managing over the edge.

"Our evidence shows one in five (U.K.) homeowners will fall into arrears when interest rates rise."

The rise in interest rates may instead force some households to borrow more, pushing them further into debt.

"This steady downward trend in insolvencies is welcome news. We must be mindful, however, of what lies ahead," Jane Tully, head of insight and engagement at the Money Advice Trust, told CNBC via email. "Household debt (in the U.K.) is forecast to pass its pre-recession peak of 169 percent of household incomes in 2020 – and unsecured borrowing is now expected to be £48 billion ($74.7 billion) higher than the Office of Budget Responsibility expected as recently as March.

"Many households will be able to accommodate this extra borrowing as the economic recovery continues – but we are concerned that many will turn to credit to plug gaps in their budgets."

Read MoreLow interest rates are the problem, not the solution

If the number of bankruptcy filings does begin to increase, it is more likely to be a gradual than immediate process, Poon told CNBC via email.

"Consumers' approach to home, auto, and credit card loans could change as the eventual rise in interest would put a strain on their household savings," he said.

"If debt and mortgages become more expensive as a result in higher rates, I would expect delinquency levels (late payments) to slowly rise and consumers' ability to pay to be pressured, resulting in higher losses that can translate to additional bankruptcy filings."

Records from the U.S. bankruptcy court show that for the year ending June 30, 2007 (around the start of the financial crisis and when the Federal Reserve's interest rate was about 5 percent) 751,056 people filed for bankruptcy.

In 2008, the number of new filings increased by 28.9 percent to 967,831 people. Over the course of 2008, the Fed cut the interest rate from 3.5 percent at the start of the year to 0.25 percent by the end, and it has remained at that level.

The number of bankruptcies increased again in 2009 by 35 percent to 1,306,315 and then peaked at 1,572,597 in 2010. It has steadily declined since then.

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Gregan Anderson, U.S. analyst for BMI Research, also expects the downward trend in bankruptcies to reverse, but for a different reason.

"The rise in bankruptcies would have less to do with higher costs for borrowers and more to do with the fact that an improving economy would pave the way for banks to hold a greater proportion of their assets as loans," he told CNBC via email.

"As banks turn increasingly towards loanmaking, relatively more risky borrowers will enter the pool of total outstanding credit. As a result, we expect that non-performing loans and bankruptcies could modestly increase over the next few years."

Overall, it is likely that incidents of bankruptcy in the U.K. and U.S. are not likely to increase, or at least not by much, as households should adapt to the small, gradual rate rises planned by the Fed and Bank of England. But, as Thaddeus Best from BMI Research points out, interest rate hikes will affect the economy in other ways.

"As real wage growth has only just begun to return to the U.K., many households are still vulnerable to rising interest rates, particularly those with high mortgage debt/income ratios," he told CNBC via email.

"Nonetheless, as households typically prioritise mortgage servicing above all other spending, the impact would be more likely to be felt in weaker discretionary spending."

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