Why the rise in payment holidays could lead to a long-term debt crisis in the U.K.

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The scale of the coronavirus-induced economic crisis has led to growing numbers of payment holidays being issued across the U.K., as the Financial Conduct Authority attempts to provide relief measures to protect struggling individual borrowers and businesses. However, many experts predict that this will lead to a mounting debt crisis — with serious implications towards the end of 2020 and into 2021.

Newly released U.K. Finance data showed that 1.82 million mortgage borrowers (approximately one in six mortgages in the U.K.) have been granted a further payment holiday extension, stretching up until October 31. With payments holidays first coming into effect in March, this takes the total window to six months.

Mortgages are far from the only loans where payment holidays have been granted. Since early April, U.K. banks have also offered a three-month freeze on payments for credit cards and personal loans for 1.2 million customers.

But such holidays are no panacea to financial difficulties, as interest continues to accumulate on the existing loan. Once the payment holiday is over, monthly repayments are likely to be higher, leaving many borrowers struggling to manage their debt, experts say. As an alternative, they advise agreeing on terms with the lender for smaller monthly repayments while the crisis is ongoing.

“Under a payment holiday, the money is still owed and interest continues to accrue, so if customers can still afford to pay something they should consider other options with their lender that allow them to do this,” said Eric Leenders, managing director of personal finance at U.K. Finance.

With several million U.K. borrowers opting for payments holidays, the coronavirus pandemic could lead to longer-term financial challenges for many households. Those who struggle to meet the higher repayments on their loans once the holiday has ended are likely to see their credit score affected.

“After credit holidays, an increasing number of customers could face difficulties in servicing their debt, which means lenders would have to enrol wide restructuring programs that could include further deferrals and indulgence for affected borrowers,” said Aslan Tavitov, senior director for the EMEA branch of credit ratings agency Fitch Ratings. “Such decisions would be made on a case-by-case basis, and would likely affect the borrower’s credit score while initial coronavirus holidays would typically not.”

The financial impact of payments holidays is also likely to extend to the industry as a whole, particularly in the mortgage sector. While the Bank of England’s latest financial stability report indicated it is confident that the U.K. banking sector has the flexibility to absorb short-term losses as a result of reduced mortgage payments, the same cannot be said for non-bank lenders such as debt funds.

“Non-bank lenders do not have access to more stable deposit funding and have to rely on the market sources that become scarce and expensive in a stressed environment,” said Tavitov. “They normally do not have access to liquidity support mechanisms from the central bank, and often carry higher risk since their target clientele is in the subprime mortgage category, which means customers with restricted access to banking services [who] are typically more prone to economic stress.”

Non-bank lenders appear likely to be particularly affected by a shortfall in revenue from the U.K. retail sector. According to the British Property Federation, only 58% of first-quarter rents were collected in 2020, compared to 99% in 2019, a figure which is likely to decrease further when the second quarter data is reported in June. While they predict that where possible, lenders will try and agree to repayment plans with property owners and retailers, continued losses could ultimately lead to a number of repossessions of assets later in the year.

“There’s a chain reaction,” said Ion Fletcher, director of policy at the British Property Federation. “Because retailers are shut, they can’t pay income to their landlords, who then can’t pay any interest to the mortgage lender. If that lender is a debt fund, it then can’t pay any distributions to its investors. If that investor base is not in a position to take that hit, it means that everybody in that chain is put in a far tougher position than if it was a U.K. bank lender. For banks, the regulators have explicitly said to be as supportive as you can, and therefore we will let you eat into your capital buffers.”

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