In Britain the terrible already has happened. There have been variable rate mortgages there for the last 35 years, and just a year ago the basic rate paid by most mortgage holders leaped from 11 3/4 percent to 15 percent in a single jump.
Payments on the average new mortgage wnet up early last year by more than 25 percent between one month and the next, an economist for the Building Societies Association in Britain said. Building societies are the British equivalent of savings and loans.
How do people cope with such enormous and uncontrollable increases in their monthly bills?
Surprisingly well, this economist says. That rise was a record and is unlikely to be repeated, although smaller rises are quite common. Most building societies offer thier borrowers the alternative of stretching out their loan when rates jump, rather than paying up the full extra amount each month.
But few people choose to do that. Apparently, out of the 5 million borrowers from building societies about 400,000 faced serious problems last year in meeting the new higher monthly costs. Most of those were young people who had just taken out a new mortgage and had not had any salary raise since.
With incomes rising at anywhere between 12 percent and 20 percent a year in the late 1970s, it took only a few years to cut down the weight of the mortgage payments in the family budget, the economist said. In addition, mortgage interest payments are tax deductible for most homeowners.
This meant that most homeowners could absorb some rise in their loan payments, even if it hurt a little. That fact, coupled with the caution of most debtors, made them unwilling to go deeper into debt by stretching out the repayment period.
Wages are not rising quite so fast now, but interest rates are falling. In recent months they have dropped 2 percentage points from the record 15 percent. r
And whereas many homeowners here take out second mortgages, or refinance as their house value rises, in Britain the proportion of debt to equity in most mortgaged properties is very low.
The average new first mortgage is worth about 80 percent of the purchase price of the house, the economist said. This drop to 50 percent for the average second-time buyer, while the overall ratio of debt to equity in all mortgaged houses is probably only 30 percent, he said.
In Britain almost all building societies charge the same mortgage rate, and, because of the variability, everybody borrowing pays the same rate regardless of how long they have had the mortgage. There are no legal limits to interest rate changes, nor are the loan rates fixed to any index.
Instead, the managers of the major societies get together and agree on the basic rate which they will charge to borrowers and pay to lenders. Unlike on this side of the Atlantic, there are also no limits on the interest rates paid by the building societies to the typically small savers who invest in them.
Both borrowing and lending rates tend, therefore, to move in line with other market interest rates. When the government's key Minimum Lending Rate moves, this usually triggers off a change in the British equivalent of U.S. banks' prime lending rate. In turn, building societies will alter their rates to ensure that adequate funds flow into the institutions to finance new mortgages.
In practice there are strong political pressures on the building societies to change rates as little as possible and to keep them as low as they can. Some societies, particularly the smaller ones, will charge higher rates but lend more generously and pay better rates to investors.
In the last decade rates have changed two or three times a year on average, the building societies association says. This is more often than during the 1960s, but there has not been a marked worsening in the last few years.
As societies hate the bad publicity surrounding rate rises, they tend to push them up all at once and bring them down in a series of smaller moves.