Changes in arrears growth and direct debit rejections reflect complex environment for borrowers
Q1 data from Pepper Advantage’s UK portfolio shows a slowdown in the growth of mortgages in arrears.1 Overall arrears increased further in the first quarter of 2024, but the decelerating growth rate and a drop in direct debit rejections suggest that lower inflation and rising wages are offering some respite for borrowers.
This report is the latest in a series that tracks mortgage data across Pepper Advantage’s UK portfolio of over 100,000 residential mortgages.
It is important to note that our portfolio has a higher composition of borrowers who qualify for needs-based support and are therefore more likely to be acutely impacted by ongoing cost of living pressures than the broader UK mortgage market. Our data reflects this concentration.
The percentage of mortgages in arrears across our UK portfolio grew 3.9% in Q1 2024 compared to Q4 2023. This compares to a quarterly growth rate of 5.7% in Q4 2023 and 7.0% in Q3 2023.
The graph below shows the growth in the arrears rate over the last eight quarters. While Q1 represents yet another post-financial crisis high, the growth rate has slowed compared to what was seen throughout 2023.
The slowing growth rate indicates improved resilience for some segments of the UK market as higher-than-expected wage growth and lower headline inflation lead to a rise in real incomes. Pressure on homeowners, however, remains high and arrears are expected to increase further into 2024.
Arrears growth in Pepper Advantage’s UK portfolio is matched by recent data from the Financial Conduct Authority that shows the value of outstanding mortgage balances in arrears grew 9.2% in Q4 2023 compared to Q3 to reach £20.3 billion — an increase of 50.3% vs. Q4 2022.
The proportion of loan balances in arrears relative to all outstanding mortgage balances grew from 1.12% to 1.23% during the quarter, marking its highest level since Q4 2016.
While it is too soon to say if the UK’s overall mortgage arrears pattern in Q1 will follow what we see in our own portfolio, an analysis of the arrears rate by product type reveals that the trend of decelerating growth in arrears applies to both fixed and variable rate mortgages.
The percentage of variable rate mortgages in arrears grew 3.9% in Q1 2024 compared to Q4 2023. This figure compares to a quarterly growth rate of 5.7% in Q4. The percentage of fixed rate mortgages in arrears grew 10.1% quarter-on-quarter compared to 13.0% in Q4. It is important to note that the growth in the percentage of fixed rate mortgages is from a low base and that the percentage of fixed rate mortgages in arrears remains small (figure 3).
The percentage of residential mortgages in arrears grew 2.9% quarter-on-quarter, the lowest growth rate since Q4 2022, when interest rates jumped above 2% for the first time since January 2009.
Buy-to-Let (BTL) mortgages also saw small growth in the arrears rate, growing 0.2 percentage points in Q1 2024 compared to Q4 2023 – a figure consistent over the last three quarters – or 11.8%. The overall arrears rate for BTL mortgages remains low, but the slow yet steady increase demonstrates the challenging environment faced by landlords and renters in many parts of the UK.
A geographic breakdown shows that every region in the UK saw slowing growth in the arrears rate except the North East and North West of England. The West Midlands and East Anglia stood out with the lowest growth in the arrears rate of only 0.4% and 0.5%, respectively.
The regions with the highest absolute rate of arrears in the UK are the North East, North West, and Yorkshire and Humberside. The South East, South West, East Anglia, and Greater London had the lowest (figure 5).
Looking at arrears by age shows that while each age group saw growth in the arrears rate quarter-on-quarter, the growth ranged from 0.1 to 0.6 percentage points compared to growth of between 0.3 and 0.8 percentage points in Q4 2023. This slowdown was particularly noticeable for mortgages owned by people aged 31-40, which grew by only 0.1 percentage points quarter-on-quarter, possibly due to a combination of stabilizing inflation and healthy wage increases, leading to real income growth.
Overall, those aged 51-60 and 60+ showed the highest level of arrears followed by those aged 41-50 (figure 6).
The percentage of residential mortgages that experienced a direct debit rejection (DDR)2 in Q1 2024 fell 2.3% compared to Q4 2023, the first quarterly decrease since Q2 2023. It is important to note that the first quarter of the year historically sees a peak in DDRs following the holiday period, with a corresponding drop in Q2. This drop in Q1 indicates that rising real incomes are supporting borrower cash flow, leading to a reduction in direct debit payments that fail because of insufficient funds.
A year-on-year analysis across Pepper Advantage’s portfolio shows that DDRs in Q1 grew 4.4% compared to the first quarter of 2023. This compares to a year-on-year growth rate of 27.6% in Q4 2023.
The UK's seasonally adjusted total DDR rates follow a similar pattern according to data from the ONS (figure 8), increasing 5% in January 2024 compared to December 2023, followed by a 3% month-on-month decline in February. This pattern follows typical DDR trends, which generally see a spike after the holiday season.
Looking at ONS data for mortgage DDRs shows that DDRs specific to mortgage payments saw no increase in January 2024 compared to December followed by a 1% monthly increase in February.
A year-on-year analysis of the data reveals a decelerating trend in DDRs specific to mortgage payments, with monthly YoY increases as follows:
This data suggests a nuanced picture when it comes to direct debit rejection rates, indicating both short-term fluctuations and longer-term trends. The observed slowdown in YoY increases may reflect broader economic shifts, potentially influenced by factors such as evolving income dynamics – specifically growth in real incomes – and reduced inflationary pressures, particularly across goods.
DDRs often serve as an early warning indicator for broader arrears. While it is too soon to know whether the recent moderation in DDR trends will continue, much less flow through to the arrears rate, it is the first sign of potentially improving economic conditions for borrowers in our portfolio.
An analysis of Pepper Advantage’s direct debit rejections across different mortgage types (figure 9) shows a drop of 8.4% in the percentage of variable rate mortgages that experienced a DDR in Q1 2024 compared to Q4 2023 and a notable YoY decrease of 9.5% compared to Q1 2023. This change is significant given the cyclical nature of DDRs.
The percentage of fixed rate mortgages with a DDR grew 1.1% quarter-on-quarter and 14.0% year-on-year. It is important to note that fixed rate mortgages had a lower overall rate of DDRs.
An examination of DDRs by age shows a similar trend. In the final quarter of 2023, every age group saw a significant year-on-year increase in DDRs that ranged from 25.3% (those aged 60+) to 53.8% (21-30).
The year-on-year growth rate was markedly lower in Q1 2024, with those aged 60+ even recording a drop of 0.2%. Those aged 51-60 saw DDRs increase by 8.5% year-on-year, while DDRs for those aged 41-50 grew 3.7% over the same period. While the two younger age groups saw higher growth rates compared to those older, these rates were still noticeably lower than in Q4 (table 1).
Pepper Advantage manages organic origination for 10 UK originators, 80% of which are capital markets funded. New originations were down only 1.4% compared to Q4 2023 and up significantly (34.1%) year-on-year, continuing the recovery seen in the second half of 2023 (figure 10). The outlook for 2024 remains positive relative to last year, reflecting higher consumer confidence, stabilizing inflation, and steady wage growth.
Pepper Advantage’s Q1 data offers some positive indicators, particularly in the form of falling direct debit rejections. Improved economic fundamentals, including rising real incomes and lower inflation, are offering a boost to borrower resilience. While it is too soon to say how sustained this resilience will prove, the green shoots that appeared in our portfolio in Q1 provide some reason for cautious optimism. These positive signs are backed by improved consumer confidence and a healthy forecast from S&P’s purchasing managers’ index, which hit 52.9% in March, comfortably above the 50-point mark that separates growth from contraction.
Despite these green shoots, the overall forecast for 2024 remains difficult, with arrears expected to continue to rise. Inflation, while lower than a year ago, remains stickier than expected, especially in services, which could result in UK interest rates remaining higher for longer. Any delay in rate reductions could lead to an elongated effect on arrears as more borrowers refinance their mortgages at higher costs. This complex economic backdrop makes it difficult to predict how soon mortgage arrears may peak, or even if the slowdown in arrears growth will continue in Q2.
The ongoing pressure on arrears we see in our portfolio is matched by the Bank of England's recent Credit Conditions Survey, which revealed that lenders reported higher default rates on secured loans to households in Q1 2024 and further, that they expect defaults to increase again in Q2. Moreover, the UK's unemployment rate jumped to 4.2% in the three months to February, rising from 3.9% in the previous period.
Pepper Advantage uses a combination of macroeconomic and portfolio analysis to identify and support borrowers who may be experiencing the strongest payment pressures, helping us to employ strategies such as term extensions and temporary interest rate reductions when and where they are most needed.
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Pepper Advantage is a global credit intelligence company that offers a range of data-led and credit management services via a technology platform that spans Asia, Europe, and the United Kingdom. The company operates in multiple asset classes including residential and commercial mortgages, real estate, SME loans, asset financing and leasing, auto and consumer loans, credit cards, retail finance and BNPL, in addition to offering a number of outsourced operational support services to both financial and non-financial clients. It helps investors, financial institutions, fintechs, and banks manage their credit portfolios, reducing the cost and complexities of systems and supporting new non-bank lending, with a particular focus on clients whose customers are underserved by traditional mainstream lenders.
Pepper Advantage's Credit Intelligence platform transforms real-time global data and analytics into valuable information, so that you can make insight-driven decisions to benefit your business and your customers’ financial experiences.
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Mortgages in arrears are those that are 30+ days delinquent in payment.
A direct debit rejection is a form of missed mortgage payment that typically occurs due to insufficient funds when a direct debit is called and is an early indicator of borrower stress. A borrower who experiences a DDR can often manage for a period before falling into arrears, which is why there is an assumed lag between rising DDRs and rising arrears.
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