Report: UK Arrears Growth Slows to 1.1%

Residential mortgage arrears drop for first time and new originations hit highest level since September 2022 Mini-Budget

Data from Pepper Advantage’s UK mortgage portfolio shows an improvement in the arrears environment in Q2 2024, with the arrears rate across the country increasing only 1.1% compared with Q1.¹ The stronger outlook was driven by residential mortgages, which recorded their first drop in arrears since Q3 2022. Q2 direct debit rejection (DDR) data also provides reasons for optimism, with overall DDRs increasing a mere 0.4% quarter-on-quarter.

Improvement in Arrears Driven by Residential Mortgages

The percentage of mortgages in arrears across our UK portfolio grew 1.1% in Q2 2024 compared to Q1. This compares to a quarterly growth rate of 3.9% in Q1 and 5.7% in Q4 2023.
 
The graph below shows the growth in the arrears rate over the last 10 quarters, demonstrating a continuation of the improvement seen in Q1 this year. While Q2 represents another post-financial crisis high in the number of mortgages in arrears, the 1.1% growth rate is the lowest recorded across Pepper Advantage’s portfolio since 2022.

The improvement in the UK arrears growth rate was driven primarily by residential mortgages, which make up the biggest part of our portfolio and recorded a 0.6% drop in the arrears rate in Q2 compared to Q1. While modest, this is the first decline in the residential mortgages arrears rate since Q3 2022, when the September Mini-Budget shocked markets and led to increased interest rates. 

Q2’s improved residential mortgages arrears rate corresponds with lower inflation, reduced energy bills, and continued real wage growth, which are supporting borrower cash flows.

Buy-to-Let (BTL) mortgages saw a markedly different performance in Q2; the arrears rate for BTL grew 10.9% quarter-on-quarter, driven by continued cost pressures on landlords as more fixed rate BTL mortgages expire and are refinanced onto higher rates. The vast majority (94.1%) of BTL loans in our portfolio are interest only compared to residential (17.5%), and BTL borrowers have a higher average loan size – 164% that of the average loan size for residential mortgages – which means they are more likely to face an outsize impact from higher interest rates.

According to recent data from UK Finance, rising rents are not increasing at the same pace as costs: “The average interest cover ratio – that’s how much of a landlord’s mortgage costs are covered by their rental income – was 342 per cent [in Q1 2018]. In Q1 2024 it was 191 per cent.” Remaining costs, such as insurance, repairs, and agency fees, are not included in this ratio.

It is important to highlight that the overall arrears rate for BTL mortgages is still low (figure 2), but the uptick in both arrears and DDR growth (more below) shows the difficulties many landlords face as they step up to higher monthly repayment amounts.

Arrears across fixed and variable rate mortgages both showed improvement in Q2, with each product type showing decelerating growth. The percentage of variable rate mortgages in arrears grew 1.0% quarter-on-quarter, compared to a 3.9% quarterly growth rate in Q1, while the percentage of fixed rate mortgages in arrears grew 5.2% vs. 10.1% last quarter.
 
As seen in the chart below, the growth in the percentage of fixed rate mortgages is from a low base and the absolute percentage of fixed rate mortgages in arrears remains small (figure 3).

Arrears growth in Pepper Advantage’s UK portfolio is matched by the most recent data from the Financial Conduct Authority which shows that the value of outstanding mortgage balances in arrears grew 4.2% in Q1 2024 compared to Q4 2023, reaching £21.3 billion — an increase of 44.5% vs. Q1 2023. These growth figures are lower than in previous quarters when the value of outstanding mortgage balances in arrears grew 9.2% quarterly and 50.8% annually.
 
Analysing arrears rates by region shows declining arrears in the North East, North West, Scotland², and Yorkshire and Humberside, which saw the arrears rate drop 2.5%, 0.4%, 8.1% and 0.4%, respectively. The West Midlands nearly joined this group with 0.0% growth.
 
While these regions have the highest absolute rates of arrears (figure 4), they are also the only regions to experience declines in the arrears rate in Q2. As with residential arrears, some of this improvement can be attributed to better cash flow, particularly with reduced energy costs, alongside the fading initial shock of higher interest rates.
 
The regions with the lowest absolute rate of arrears – the South East, South West, East Anglia, and Greater London – recorded growth in their arrears rate of 3.4%, 3.2%, 1.1% and 6.0%, respectively. Wales saw growth of 1.5% and the East Midlands 0.2%.

While borrowers in more Southern regions would also benefit from improved cash flow and lower energy costs, the average loan sizes of the mortgages in our portfolio in these areas are higher, particularly in London and East Anglia. These larger loan sizes correspond with  greater monthly repayment increases as more borrowers refinance mortgages at higher interest rates.

Each age group saw an increase in arrears in Q2, with growth ranging from 0.3 to 0.7 percentage points, compared to growth of 0.1 to 0.6 percentage points in Q1. Those aged 21-30 and 31-40 showed the lowest rate of arrears, while those aged 51-60 and 60+ showed the highest level of arrears (figure 5).

Direct Debit Rejections Essentially Flat

The percentage of residential mortgages that experienced a direct debit rejection (DDR)³ in Q2 2024 grew 0.4% compared to Q1 2024, continuing the improved DDR environment seen in Q1. The more optimistic outlook in the first half of the year reflects growth in real incomes and lower inflation, which together are supporting borrower cash flow, in turn reducing the number of direct debits that fail because of insufficient funds in accounts at the time a payment is called.
 
A year-on-year analysis across Pepper Advantage’s portfolio shows that DDRs in Q2 grew 8.7% compared to the same quarter last year. This compares to a year-on-year growth rate of 27.2% in Q2 2023. The cyclical nature of DDRs highlights the improved economic environment in the second quarter of 2024 compared to the same period last year, when high energy and living costs combined with rising interest rates shocked UK budgets.

As with arrears, residential mortgages showed the most improvement in DDRs. The percentage of residential mortgages that recorded a DDR fell 7.3% in Q2 compared to Q1 this year. This follows a 4.0% quarterly fall in Q1 and represents the first back-to-back months of decline in DDRs for this group since 2021.
 
Buy-to-Let again broke dramatically with residential payment patterns in Q2; the percentage of BTL mortgages that experienced a DDR rose a significant 31.3% compared to Q1, driven by the same factors highlighted above. This compares to quarterly growth of 4.6% in Q1 (figure 7).

Looking across mortgage types reveals an 8.3% decline in the percentage of variable rate mortgages with a DDR in Q2 2024 compared to Q1 2024, which is roughly equal with the drop seen in this same group in Q1. The DDR rate for fixed rate mortgages grew 4.2% quarter-on-quarter, compared to quarterly growth of 1.1% in Q1. It is important to note that fixed rate mortgages continue to have a lower absolute DDR rate than variable (figure 8).

An examination of DDRs by age shows all groups except those aged 51-60 saw a modest decline in DDR rates in Q2 compared to Q1 that ranged from 0.01 to 0.2 percentage points. The percentage of mortgages of those aged 51-60 with a DDR rose 0.3 percentage points (table 1).

New originations hit highest level since Mini-Budget

Pepper Advantage manages organic origination for 10 UK originators, 80% of which are capital markets funded. New originations in Q2 2024 increased 20.9% over Q1 and 53.5% over the second quarter of 2023, hitting the highest level since Q4 2022, the last quarter before the full effects of the UK’s 2022 Mini-Budget reached markets.
 
The outlook for new originations in the second half of 2024 remains positive, with more competition from lenders leading to tighter pricing for borrowers.

An uneven recovery

Pepper Advantage’s Q2 data shows an improving environment for some UK mortgage holders, but it is important to note the tenuous and uneven signs of recovery in our portfolio. A slight fall in the residential mortgage arrears and DDR rates alongside a rebound in new originations are the strongest reasons yet for optimism; however, the UK’s transition from a low to high-interest rate environment is still in progress, with millions of borrowers set to refinance to higher rates over the coming months. As we see in the BTL market, the consequences of this refinancing are still emerging, and arrears overall grew at a rate of 1.1%.

While BTL mortgages remain relatively resilient in that the absolute arrears rate remains low, the fact that we are starting to see an uptick in arrears is a warning sign that structural challenges could be emerging. Data from the ONS shows that rents across UK regions have increased five to seven percent year-on-year, but as reflected in the data from UK Finance mentioned above, this increase is often not enough to cover higher mortgage repayments alongside other costs, leading to the stress signals in our portfolio.

Pepper Advantage’s data shows that certain groups remain under pressure, and all eyes will be on the Bank of England when it announces its rate decision August 1. While a summer rate cut would be welcome news for borrowers, there would be a significant lag before borrowers feel the benefits of any cut and the impact of slightly lower rates on monthly repayments is likely to be modest.

The ongoing challenges facing certain segments of borrowers are a key reason Pepper Advantage continues to analyse macroeconomic conditions and data from its portfolio to find and support borrowers who are most at risk of payment difficulties. Early identification of risks helps us to employ strategies such as term extensions and temporary interest rate reductions where they are most needed.

For more information, please contact us here.

Why Pepper Advantage?

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.

To find out more about Pepper Advantage and our Credit Intelligence platform, click here.

1. Mortgages in arrears are those that are 30+ days delinquent in payment.

2. Scotland’s strong performance is due to an increase in new mortgage accounts in our portfolio not in arrears alongside a modest drop in the number of accounts in arrears, leading to an outsized decline in the arrears rate.

3. 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.

Disclaimer

The material contained in this Article (the “Material”) has been prepared by Pepper Advantage Technologies Limited (“Pepper”).

No representation or warranty, express or implied, is or will be made with respect to the accuracy, completeness, usefulness or merchantability of the Material or its fitness for a particular purpose or regarding the accuracy of the assumptions or the output or the appropriateness of the parameters used in the calculation of any projections or estimates set out herein or the correlation of the data to the actual or expected performance and characteristics of any transaction and no liability or responsibility is or will be accepted by Pepper or any of its affiliates or associated companies or any of their respective directors, officers, employees or agents in relation thereto. Any use of the Material by the Recipient for any purpose whatsoever will be entirely at the Recipient’s own risk.

This Material may utilise information which has not been independently verified and may include that from public sources and third parties (including market and industry data). Further, this Material may contain forward-looking statements, estimates, forecasts and projections that may be affected by inaccurate assumptions, expectations and estimates and by known or unknown risks and uncertainties are predictive in character and inherently speculative and may or may not be achieved or prove to be correct. The Recipient should not place reliance on such statements.

By accepting the Material, the Recipient acknowledges that (a) Pepper is not in the business of providing advice including legal, tax or accounting advice, (b) there may be financial, legal, tax or accounting risks associated with any transaction, (c) it will seek advice from advisors with appropriate expertise to assess relevant risks and independently determine, without reliance upon Pepper, the economic risks and merits of any transaction and that it is able to assume any such risks and that (d) nothing herein shall form the basis of or be relied on in connection with any contract or commitment whatsoever and neither Pepper nor any of its agents accept liability for any loss howsoever arising, whether direct or consequential, from, related to or in connection with any use of the Material or otherwise arising in connection herewith.

Your receipt and use of the Material constitutes notice and acceptance of the foregoing.