Mortgage holiday extension cuts chance of crash - Capital Economics
UK Housing

Mortgage holiday extension cuts chance of crash

UK Housing Market Update
Written by Hansen Lu

The extended mortgage holiday scheme will cushion the blow for financially distressed households. Alongside the other financial support already available, it further reduces the chance of an immediate house price crash. But large downside risks to house prices remain.

  • The extended mortgage holiday scheme will cushion the blow for financially distressed households. Alongside the other financial support already available, it further reduces the chance of an immediate house price crash. But large downside risks to house prices remain.
  • A three-month extension to the mortgage holiday scheme has just been announced. Borrowers using the holiday were originally due to resume payments in late June or July. But they can now extend that holiday for a further three months, delaying the resumption of payments to at least September.
  • The scheme is a substantial financial cushion for mortgage borrowers. For example, a typical homeowner with a £200,000 mortgage, paying an interest rate of 2.5% on a 25-year loan can now delay £5,400 of mortgage payments over a six-month period. For those living in places with higher house prices, such as London, the level of financial support is even greater. (See Chart 1.)
  • Of course, delayed payments are still owed to banks. Principal and interest accrued during the holiday will typically be repaid over the remaining loan term. But, assuming the borrower’s financial position recovers, the rise in payments shouldn’t be onerous. Using the above example, a six-month holiday taken five years into the mortgage term would increase the remaining payments by just £30 a month.
  • All this is part of policymakers’ broader strategy, and reflects lessons learned from previous crises. From a lender’s perspective, loans become riskier during a downturn, so banks have an incentive to pull credit from existing borrowers and reduce new credit supply. But withdrawing credit from financially distressed homeowners creates more forced sellers, while reduced credit supply cuts housing demand. In aggregate this behaviour can deepen a downturn in asset prices.
  • This can fuel a vicious cycle, as further house price falls make banks even more cautious. There is evidence of this happening during the global financial crisis. While the initial credit crunch was triggered by wholesale funding problems, survey data from the time suggests that the drop in mortgage availability was sustained by fears around house prices and the economy. (See Chart 2.)
  • Mortgage holidays instead cushion the blow for financially distressed households – reducing the probability they will become forced sellers. Moreover, broader financial support for households is available – for example, through the furlough scheme. Policymakers have also provided cheap funding for banks through the new Term Funding Scheme, while also cutting regulatory capital requirements. These measures make it easier for banks to practice forbearance.
  • Taken together, policy action is dampening households’ financial distress. It is a key reason why, despite the huge hit to the economy, we expect house prices to fall modestly this year, and not crash. But forbearance and government handouts can’t keep asset prices afloat forever. There are serious downside risks to our house price forecast, which we will explore in an upcoming Focus.

Chart 1: Illustrative Delayed Mortgage Payments by Region (£)

Chart 2: Lenders’ Reported Factors Affecting the Availability of Credit (% Balance)

Source: Capital Economics

Source: Bank of England


Hansen Lu, Property Economist, hansen.lu@capitaleconomics.com

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