Britain's low interest rate environment is a blessing and a curse for homeowners

The Bank of England has kept rates at a record low of 0.5% for the 83rd month in a row.

Homeowners and others with a lot of debt will be rejoicing at the unanimous 9-0 decision by the BoE’s rate setting panel — the Monetary Policy Committee — to keep rates low.

This is because low interest rates help those in debt to make repayments and boosts the amount of money in people’s pockets. It ultimately stimulates the economy because it lowers the cost of borrowing.

But this is a short term blessing for homeowners, which have a huge debt pile in the form of a mortgage, but a curse in the long term.

Here’s why.

1. It fosters an environment where taking on huge amount of debt is the norm

The low interest rate environment in Britain is getting more people on the housing ladder. People are taking on more debt in the form of a mortgage and repayments are at a steady rate because rates haven’t moved since 2009.

While some people may know that interest rates can’t stay low forever, it hasn’t stopped many trying to capitalise on favourable borrowing costs.

Halifax noted today in its monthly House Price Index report that mortgage approvals are still rising steadily, means more people are getting approved by their banks to buy a home.

“The volume of mortgage approvals for house purchases — a leading indicator of completed house sales — increased by 1% between Quarters 3 and 4 of 2015. Approvals in the final three months of 2015 were 18% higher than in the same period a year earlier,” it said in the report.

Overall for 2015, home sales in Britain totalled 1.23 million in 2015, which is higher than the 1.22 million recorded in 2014.

Interestingly, after the Bank of England’s governor Mark Carney signalled in the summer of last year that rates may rise “at the turn of this year,” property sales picked up during the year with transactions in the second half of 2015 — 6% higher than in the same period in 2014.

There’s precarious situation developing where people are borrowing way beyond their means because wages are still not growing at the same rate as house prices.

Halifax said in its note today that property prices averaged £212,430 after prices in the three months to January were 9.7% higher than in the same three months a year earlier.

But wage growth is week. Average weekly wages are £27 below their pre-credit crisis 2007 peak of £490 after growing by only 2% in the three months to November.

For an annual figure, the High Pay Centre pegs the average British wage at £26,500.

And herein lies the rub — the ratio between house price and earnings growth is increasing sharply, meaning people are taking on debt more quickly than their wages are rising. This Halifax chart shows the steady increase:

This leads to problems when rates do rise.

2. Interest rate hikes will be more painful in the long term

Worryingly, according to the charity Money Advice Trust last month, 40% of people are not aware that rates may rise, indicating they are likely to not be prepared for an increase in debt payments — especially those who are homeowners.

That’s a pretty big deal. If you’re already scrimping or just about OK repaying your current monthly mortgage bills, then you’ll struggle if rates rise.

Economist Robert Wood, and his team at Bank of America Merrill Lynch said last month that rates are likely to rise by the end of the year and then hiked three more times in 2017.

So by 2018 there could be a wave of homeowners struggling to make ends meet. Laith Khalaf, Senior Analyst, Hargreaves Lansdown said in a statement sent to Business Insider this morning that (emphasis ours):

Of course low interest rates have kept the wheels turning, albeit slowly, and many people are still enjoying low mortgage payments as a result of loose monetary policy. However the danger is the longer interest rates stay low, the more comfortable people get with higher levels of debt, and the more painful rate rises eventually prove to be.

Sure, there is always speculation that Britain may cut interest rates again because some central banks like the ECB and Bank of Japan has done this before, but, inevitably, rates will rise again eventually.

Already some people, who are worried about rate rises, are already freaking out about a small rise — let alone several rises.

A 1% hike is only equivalent, when looking at standard variable rate mortgages, of paying an additional £55 a month for every £100,000 owed.

Last year, Ocean Finance revealed that 7 million property owners would struggle with their mortgage payments if interest rates edged up by just 1%. ICM Research also showed that a third of mortgage borrowers would struggle to meet repayments if interest rates rose by 2%.

While the Money Advice Service warned that more than half of homeowners are not prepared for interest rate rises. Even more worryingly, 19% said they would really struggle to cover any rise in interest rates in their monthly repayments and 47% of people would find it hard to cover an increase of up to £150 extra a month.

So all in all, homeowners may be happy right now that mortgage payments are manageable but unless they start preparing now for that hike, they will find themselves hitting the ground hard when rates do rise again.

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