‘Debt Peril’ Awaits 1.25 Million UK Households If Rates Rise

Caroline Purser | Photographer's Choice | Getty Images

Up to 650,000 more U.K. households face "debt peril" if mortgage rates rise unexpectedly before the economy returns to full strength, a think-tank warns.

The Resolution Foundation said on Thursday that 1.25 million households would have to spend half their disposable income on repayments by 2017 if the Bank of England's official rate rose 2 percentage points higher than forecast without a recovery in wage growth.

(Read More: Bank of England Offers Ray of Hope for UK Economy)

While more people between 35 and 50 borrowed heavily than other age group, a surprise rise in mortgage rates would hit younger borrowers disproportionately, according to the research. Families with children were more at risk from "debt peril" than childless couples and single adults. The poor were also more vulnerable – 7 per cent of the poorest fifth of households would see more than half their income eaten up by debt repayments if rates rose unexpectedly, compared with 3 per cent of the richest fifth.

The study highlights the threat to recovery posed by UK households' high debt burden, accumulated during the boom years.

At the height of the boom in 2007, 870,000 households faced repayments that were equivalent to half their income or more. The number of households in "debt peril" fell almost a third between 2007 and 2011, as official rates plunged from 5.5 per cent to their current record low of 0.5 per cent.

(Read More: UK House Prices Gallop Higher in June)

But, while mortgage default rates have been far lower here than in the US, Britons have proven less willing than their American counterparts to take advantage of low rates to repay loans. The U.K.'s fiscal watchdog, the Office for Budget Responsibility, projects the total household debt burden to rise in the years ahead to 151 per cent of income by 2018.

More From The Financial Times:

Latest Round of UK Regional Growth Fund Offers £506m
IMF Revises Up UK Growth Forecast

Matthew Whittaker, an economist at the Resolution Foundation, said: "It is not clear that we are doing enough while we have breathing space."

The publication of the research coincides with dramatic movements in yields on US Treasuries amid signs that the Federal Reserve could soon slow the pace of its bond buying. The movements, which have pushed up borrowing costs in the U.K., led Mark Carney, the BoE's new governor, and the rest of the Monetary Policy Committee (MPC) to rip up its rule book on central bank communications last week and warn that rises in market interest rates were "not warranted".

The bank launched an inquiry last week into the vulnerability of borrowers and financial institutions to a sharp rise in long-term interest rates.

But at a panel to mark the launch, David Miles, a member of the MPC, said a rise in the number of households facing "debt peril" did not present a serious threat to the economy.

(Read More: UK House Prices Rise at Fastest Pace in 3 Years)

While the MPC was "very aware" of the problems raised by the research, Mr Miles queried the likelihood that rates would rise before the economy, and wages, picked up. Mr Miles said: "Is that really a plausible combination of events?" He said it was "highly plausible" that rises in mortgage rates would lag behind any tightening of monetary policy.

Kate Barker, a former monetary policy maker, said: "These are not numbers to be alarmed about . . . From a macro point of view, this is manageable: from a micro point of view, it will be difficult."