While interest rates remain at rock-bottom, mortgage borrowers who are on the edge of not being able to afford their repayments are being given a reprieve, but what happens when rates inevitably start to rise?

When the credit crisis broke and interest rates started to tumble, some mortgage payments got lower as household finances were simultaneously squeezed, granting some much-needed relief to those on the verge of losing their homes, although many others were not so lucky.

The Government has introduced various measures to shore up repossessions, working with lenders to use this as a last resort and encouraging them to help borrowers remain in their homes wherever possible.

Economists are at odds as to when interest rates will start to rise, but rise they will, whether it is in the New Year or not for another two years, and industry experts are concerned that those borrowers who are on the edge and staring into the abyss, will not be able to keep pace with their rising payments when interest rates do start to go up.

Financial analysts at Fathom Consulting believe that the UK is heading for another credit crisis, because there are still huge numbers of homeowners who are on the brink of defaulting on their mortgages; it has made the controversial proposal that this should be accelerated to get it over with, by creating a ‘bad bank’ to buy up all of the risky mortgages.

Danny Gabay of Fathom refers to “zombie households” which are in a state of limbo. In Stephanie Flanders’ interpretation of the report on her BBC blog, the current situation has created these households which can “only stay afloat because the cost of servicing their mortgage has fallen through the floor. As a result, banks don’t have to face the fact that their mortgage-based assets are worth much less than they were at the peak of the boom – and the country can’t move on.”

Mr Gabay is of the belief that keeping these mortgages alive by drip-feeding banks, and keeping interest rates low, is only putting off the inevitable, prolonging banks’ reluctance to lend, and means that “we can’t move forward.”

As part of its spending review, the Government announced an extension of the temporary concession on Support for Mortgage Interest, including reducing the waiting period for new working age claimants to 13 weeks and increasing the limit on eligible mortgage capital to £200,000, both due to expire in January 2011, which will now remain in place for another 12 months, assisting those borrowers on benefits trying to meet the interest payments on their loan.

The Council of Mortgage Lenders welcomed this move to help those who “through no fault of their own, lose their income and their ability to meet their mortgage obligations,” but it has voiced its concern regarding what will happen when the extension comes to an end, urging the Government to come up with an alternative.

Fathom has suggested one possible solution, but as Stephanie Flanders noted, “The Monetary Policy Committee are unlikely to follow their advice.”

© Fair Investment Company Ltd