Report: UK Mortgage Arrears Fall to Lowest Level since 2022 but Buy-to-Let Arrears Rise

Report summary: Q3 data from Pepper Advantage’s UK mortgage portfolio shows that the arrears environment for residential mortgages continued to improve – albeit slightly – with a 0.8% drop in the arrears rate relative to Q2 2024. The arrears rate for buy-to-let (BTL), however, continued to rise, increasing nearly 10% quarter-on-quarter. The BTL environment is now showing more stress than residential – a reversal of the trend seen during the cost-of-living crisis and an indication of structural challenges emerging in the BTL market.

Overall arrears flatline; growing BTL arrears signal longer-term challenges

The percentage of mortgages in arrears across our entire UK portfolio grew a mere 0.1% in Q3 2024. The 0.1% growth rate seen last quarter compares to 1.1% growth in Q2 and 3.9% in Q1.

As seen in the graph below, the overall arrears rate in the UK has plateaued following the steep rises seen throughout 2023. The 0.1% growth rate is the lowest recorded across Pepper Advantage’s portfolio since Q3 2022, when arrears fell 0.6%.

For the second quarter in a row, the improvement in the UK’s overall arrears rate was driven by residential mortgages, which saw a decline of 0.8% following the 0.6% drop seen in Q2. Residential mortgages make up the largest part of our portfolio, and the continued if slight improvement in arrears for two consecutive quarters is the most promising sign yet that UK borrowers are recovering some financial footing. This improvement is being driven in part by lower inflation, which fell to 1.7% in September -- the first time in three years that it has fallen below the Bank of England’s 2% target.

Buy-to-let arrears, however, had another difficult quarter and we are now seeing signs of structural stress emerging in our BTL portfolio. The Q3 arrears rate for BTL mortgages grew 9.7% compared to Q2 – when arrears rose 10.9% relative to Q1 – and 46.1% compared to the third quarter of 2023.

Additionally, the number of BTL mortgages dropped 1.6% in Q3 relative to Q2 and 10.6% compared to this time last year. These figures correspond with an average interest rate of 4.83% for BTL mortgages compared to an average interest rate of 4.35% in Q3 2023 and 3.38% in Q3 2022.

Over 90% of buy-to-let mortgages in our portfolio are interest only compared to less than 20% of residential, which means BTL borrowers have a higher average loan size and are therefore more likely to be heavily impacted by higher interest rates as fixed rate mortgages expire and are refinanced onto higher rates. We are seeing more BTL landlords sell and exit the market as a result.

While the overall arrears rate for BTL mortgages is still lower than residential (figure 2), the second consecutive quarter of outpaced arrears growth indicates that the challenges in the BTL market have yet to reach their peak.

Looking at arrears by fixed vs. variable rate mortgages shows that the overall improvement seen in Q2 continues, with the arrears rate across fixed rate mortgages dropping 0.1% in Q3. The arrears rate for variable rate mortgages remained relatively steady, with a low 1.1% growth quarter-on-quarter.

As seen in the chart below, the change 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).

Data in our portfolio that shows an improving arrears environment for residential mortgages is matched by UK Finance, which showed that the number of homeowner mortgages in arrears in the third quarter of 2024 fell 3% relative to Q2. The number of BTL mortgages in arrears fell 4% quarter-on-quarter according to this same data set but rose 18% year-on-year.

Analysing arrears rates by region shows declining arrears in the North East, North West, Scotland, the South West, and Yorkshire and Humberside, which all saw their arrears rate drop in Q3 compared to Q2.

The South West is a new regional entrant to this group with a decline in the arrears rate of 1.5% -- the first decline in this region since 2022. The West Midlands just missed joining for the second quarter in a row, with a Q3 growth rate of a mere 0.1%. Greater London recorded its lowest growth rate since 2021 – only 0.4%. This compares to a Q2 growth rate of 6.0%.

Each age group saw decelerating growth rates in Q3 2024 relative to Q2, with growth ranging from 0.2 to 0.6 percentage points, compared to growth of 0.3 and 0.7 percentage points in the previous quarter (table 1).

Those aged 31-40 (more likely to be first time buyers) saw the biggest increase of 0.6 percentage points quarter-on-quarter and 2.6 percentage points year-on-year.

Direct Debit Rejections Tick Up

The total percentage of UK mortgages that experienced a direct debit rejection (DDR)^[1] in Q3 2024 grew 1.9% quarter-on-quarter compared to the 0.4% quarterly growth seen in Q2. This increase, while slight, is a data point we are watching closely in Q4 as cash flow challenges are often at their highest during the holiday period.

The percentage of residential mortgages with a DDR in our portfolio rose 1.7% in Q3 compared to the previous quarter, the first increase seen this year after two consecutive quarters of decline (figure 7). The slight increase in residential DDRs indicates that we are not out of the woods yet and underlines the fragile nature of the UK’s economic recovery. However, it is important to note that the DDR rate for residential mortgages in Q3 2024 was 0.5% lower than it was in Q3 2023, when the cost-of-living crisis was acute.

The DDR rate for buy-to-let mortgages grew 2.7% quarter-on-quarter and 36% year-on-year, again highlighting the stress we are seeing emerge in our BTL portfolio (see above).

In Q3, the percentage of variable rate mortgages with a DDR grew 5.6% compared to Q2, while the DDR rate for fixed rate mortgages grew 0.6%. It is important to note that fixed rate mortgages continue to have a lower absolute DDR rate than variable (figure 8).

Looking at -DDRs by age again shows a slight increase across almost all age groups, with growth ranging from -0.08 to 0.39 percentage points (table 1).

New originations steady

Pepper Advantage manages organic origination for 10 UK originators, 80% of which are capital markets funded. New originations in the third quarter dropped 7.6% compared to the high seen in Q2 2024 (which grew a whopping 20.9% over Q1), continuing the better performance seen in 2024 over 2023 (table 3). The outlook for new originations heading into the final quarter remains relatively steady, with lower interest rates and increased activity in the housing market leading to more demand, especially among first-time buyers who may be looking to capitalize on stamp duty relief before it expires in April.

Mixed Signals Warrant Caution 

We continue to see mixed signals across our portfolio, with arrears flattening out and falling residential arrears providing optimism that UK households are not experiencing new stressors. Rising BTL arrears, however, provide reason for caution and could compound financial pressures on renters. We are also keeping a close watch on direct debit rejections, especially as the holiday season could lead to increased pressure on household budgets.

This uncertain outlook is matched by broader economic data. Lower inflation has provided relief for many UK households, but consumer confidence remains a concern. GfK’s Consumer Confidence Index dropped one point in October to -21, reflecting increasing pessimism about the general economic outlook despite slight improvements in personal financial expectations.

The labour market also offers mixed signals. Unemployment rose to 4.3% in the July-September period, up from 4.0% in June-August. Wage growth, however, continues to support households, with average regular earnings (excluding bonuses) growing at an annual rate of 4.8%, the highest since mid-2022. The Bank of England’s rate cuts could also support households refinancing mortgages, but there is a significant lag before borrowers feel the benefits of any cut and rising UK swap rates mean the underlying cost of borrowing may or may not improve in line with the Bank of England base rate.

This uncertain outlook for borrowers is why Pepper Advantage constantly analyses 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.

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1. 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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