Increasing interest rates by 1% would cost UK individuals an extra £7.6 billion in borrowing costs in the next year, according to research from the Restructuring and Insolvency team.
Mark Carney has suggested that the new ‘normal’ interest rate could increase from 0.5% to 2.5% in the medium term and that the Bank of England is preparing for interest rate rises.
Even if interest rates increased by just 0.25% over the next year, then extra borrowing costs for individuals would total £1.9 billion (see chart 1). Immediate costs would be far higher if consumers had not already switched to longer term, fixed rate mortgages.
The impact of the interest rate rise will accumulate in subsequent years as more peoples’ fixed rate mortgages come to an end.
Interest rates are currently at such low levels that even a small rise of 0.5%, for example, would cause a dramatic 17% rise in interest costs (on average) to borrowers on floating rate mortgages.**Chart 1: Cost of extra interest payments for individuals over 1 and 2 years
(Total of mortgage loans, credit card debt and other household loans)
Michael Finch, Partner in the Restructuring and Insolvency team comments: “Rising interest rates could be very bad news for individual borrowers.
“For those that have recently stretched themselves to buy a home, the hike in interest rates could be devastating. Increasing interest rates on mortgages have the potential to push many financially over-stretched borrowers into bankruptcy.”
The impact of interest rate rises will be widespread but points out that borrowers with interest-only mortgages that are reaching the end of their mortgage term could be particularly hard-hit. This is because lenders, under pressure from the FCA, are requiring these borrowers to switch to repayment mortgages, meaning extra monthly repayment costs on top of higher interest rates.The effect of rising interest rates for businesses
Rising interest rates would also have a huge impact on UK businesses, with approximately an extra £2.1 billion in borrowing costs in the next year if interest rates increase by 1%.Chart 2: Cost of extra interest payments for businesses over 1 and 2 years
(Total of private non-financial corporation loans – excludes lending to the financial services sector)
Michael Finch comments: “The economy is definitely improving, but interest rates rises could threaten the recovery. We need to ensure that the increase in interest rates is the equivalent of taking away the punchbowl, not turning off the oxygen.
“Businesses need to be realistic and start budgeting for a higher cost of debt now so that they are not caught out when interest rates do go up. Businesses that think their solvency might be put at risk by higher interest rates would be well advised to work with independent professional advisers to look at ways their business could be restructured to survive.”
Mike explains that even without the increase in interest rates, the economic recovery could still heighten the risk of insolvency for some businesses because:
Chart 3: Current value of loans outstanding
- businesses often deplete their accumulated cash reserves during the recession so they become more dependent on raising finance to provide working capital during the recovery;
- better trading conditions may make creditors more bullish and willing to crystallise their losses by calling in outstanding debts;
- as the value of assets such as commercial property, plant and machinery improves with the economy, then creditors to struggling businesses are more willing to force the winding up of that business as they are more likely to recover some of the value of their debts from the sales of those assets; and
- during the recession there is more pressure on creditors not to pull the trigger on struggling businesses from politicians who want to avoid a wave of business failures, but as the economy continues to improve this pressure fades.
(Business: total of private non-financial corporation loans – excludes lending to the financial services sector)
* Estimates based on an analysis of Bank of England data
** based on average floating rate mortgage
Related linksRestructuring and insolvency