First Drop in UK Arrearrs Rate Since Q3 2022
Report summary: Data from Q2 2025 shows that arrears in Pepper Advantage’s UK mortgage portfolio have dropped for the first time since Q3 2022. The overall arrears rate fell 4.4%, driven by a 4.7% decline in the residential arrears rate. Direct debit rejections also fell 5.1% in Q2, marking the first quarter that both metrics have fallen since the COVID-19 pandemic.
This report is the latest in a series that tracks mortgage data across Pepper Advantage’s UK portfolio of over 100,000 residential mortgages.
It is important to note that our portfolio has a higher composition of borrowers who qualify for needs-based support and are therefore more likely to be acutely impacted by cost of living pressures than the broader UK mortgage market. Our data reflects this concentration.
The percentage of mortgages in arrears across our UK portfolio fell 4.4% in Q2 2025 compared to the previous quarter (figure 1). This is the first drop in the arrears rate seen in our portfolio since Q3 2022, when the cost-of-living crisis began, and the most dramatic change since Q4 2023, when inflationary pressures on household budgets were at their most acute.
The fall in the arrears rate was driven by significant improvement in Pepper Advantage’s residential mortgage portfolio, which saw the arrears rate drop by 4.7% in Q2 (figure 2). This decline follows two consecutive quarters of modest growth, marking a noticeable reversal for this segment of the market and signaling potential improvement in UK household finances.
The Buy-to-Let (BTL) arrears rate increased modestly by 0.9% in Q2 2025, following a quarterly decrease of 0.1% in Q1 2025. The arrears rate in the BTL market stabilized in the first half of 2025 relative to the same period last year, when it rose over 10% in both Q1 and Q2. However, the current arrears rate is still 9.5% higher than it was in Q2 2024, indicating that the situation for small UK landlords, while steadying, remains challenging in a higher rate environment.
While the BTL arrears rate since 2022 correlates with changes in interest rates (figures 3 and 4), the residential arrears rate since 2024 has shown a stronger correlation with the UK’s Consumer Prices Index, including owner/occupiers' housing costs (CPIH) (figures 5 and 6).
As seen above, the arrears rate for residential mortgage holders has shown a directional correlation with CPIH since 2024. However, it experienced a significant decline in Q2 2025 compared to CPIH. This drop may be attributed to the improvement in CPIH during the first quarter, combined with the positive impact of earlier interest rate reductions, which together strengthened UK household finances and supported our residential mortgage portfolio in Q2.
This improvement is also evident when we analyze arrears by product type: the percentage of fixed rate mortgages in arrears decreased by 0.8%, while the percentage of variable rate mortgages in arrears fell by 2.3% compared to the previous quarter (figure 7).
An analysis of regional data shows a drop in the arrears rate in every single region across the UK1, the first time this has happened since Q2 2021.
The universality of the drop in arrears across our portfolio indicates that UK household budgets are benefiting from less acute inflationary pressures and lower interest rates. This conclusion would be supported by recent data from the Bank of England, which shows that “households’ deposits with banks and building societies increased by £4.3 billion in May, following net deposits of £2.8 billion in April.”
There is, however, one exception: in Q2 2025, there was a split between older and younger groups, with only the two oldest groups seeing a drop in arrears rates (figure 9). However, it is important to note that the absolute arrears rate for younger groups remains lower than that of older groups, with younger homeowners supported by strong employment figures and lower average mortgage balances.
The improvement in Pepper Advantage’s mortgage portfolio is also evident when looking at direct debit rejections, a type of missed payment that often serves as a leading indicator of portfolio health.
The direct debit rejection rate (DDR) in Q2 2025 fell by 5.1% compared to the previous quarter (figure 10). While DDRs are cyclical and often peak in Q1 following the holiday season, the decline in Q2 represents the largest drop in our portfolio since the COVID-19 pandemic in Q1 2021.
The decline in both the DDR and arrears rates indicates that the economic environment for UK homeowners has improved as the effects of lower CPIH and interest rates are supporting cash flow. However, the seasonality of DDRs makes it difficult to forecast if the improvement seen in Q2 will continue in Q3 and Q4.
An analysis of the direct debit rejection (DDR) rate for residential and buy-to-let (BTL) mortgages shows improvement for both homeowners and landlords. Residential DDRs decreased by 4.2%, while BTL DDRs fell by 8.4% quarter-on-quarter – a larger than usual seasonal drop (figure 11).
The significant decline in the percentage of BTL mortgages experiencing a DDR suggests that the positive trend observed in Q1 is not a one-off occurrence but rather reflects a more fundamental change in landlords’ financial positions. This change correlates with lower interest rates compared to a year ago, when the number of BTL mortgages with a DDR reached an all-time high within our data set.
Direct debit rejection rates also fell across both fixed rate mortgages (-5.3%) and variable rate mortgages (-3.1%) and across every region in the UK:
The relative improvement in DDRs was greatest in East Anglia (-13.6%), the North East (-10.4%), North West (-8.9%), Scotland (-8.9%) and the South West (-7.4%).
In contrast, Greater London, Yorkshire and Humberside, the West Midlands, Wales, and the South East saw their DDR rates fall by -0.9%, -1.6%, -2.4%, -3.6%, and -3.6%, respectively.
Only one group experienced an increase in their direct debit rejection (DDR) rates in Q2 2025: mortgage holders aged 21-30, whose DDR rate rose by 0.2 percentage points. This age group tends to be at the lower end of the income scale, so costs easing across the wider market may not have had as big of an impact on this cohort.
Pepper Advantage manages organic origination for over 10 UK originators, 80% of which are funded by capital markets. New originations in Q2 2025 fell by 3.2% compared to Q1 2025 (figure 13), reflecting the impact the expiration of the stamp duty holiday in March had on demand; new originations peaked in March and then dropped significantly in April as prospective homeowners rushed to complete their transactions before March 31.
While demand for mortgages recovered in May and June, it was not enough to offset the April shortfall. This matches data from the Bank of England, which showed mortgage debt grew by £2.8 billion to £2.1 billion in May, following a large decrease in April.
Q2 2025 showed the first improvement in arrears rates since the cost-of-living crisis began in 2022. The Q2 performance, combined with the promising start to the year made in Q1, offers hope that UK homeowners are finally seeing sustained relief from the compound pressures of interest rate increases and rising living costs.
It is important, despite this positive momentum, to recognize the potential challenges that lie ahead. With inflationary pressures and possible tax increases on the horizon, there is a risk that household budgets could come under renewed strain. These factors may lead to a reversal of the progress made in arrears in the first half of 2025, and we remain cautious as we continue to monitor the health of our UK portfolio.
According to the Financial Times, “‘anxious’ British households are prioritising saving money over spending more than at any point since the global financial crisis” and are working to rebuild financial buffers. Moreover, inflation rose higher than expected in June and further upward pressure on prices could influence budgets later in the year.
We are cautiously optimistic as we enter H2 2025, but the potential for external shocks to impact financial stability remains a concern. We continue to focus on ensuring strategies are in place to support households given lower consumer confidence and ongoing economic uncertainty.
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Pepper Advantage is a global credit intelligence company that offers a range of data-led and credit management services via a technology platform that spans Asia, Europe, and the United Kingdom. The company operates in multiple asset classes including residential and commercial mortgages, real estate, SME loans, asset financing and leasing, auto and consumer loans, credit cards, retail finance and BNPL, in addition to offering a number of outsourced operational support services to both financial and non-financial clients. It helps investors, financial institutions, fintechs, and banks manage their credit portfolios, reducing the cost and complexities of systems and supporting new non-bank lending, with a particular focus on clients whose customers are underserved by traditional mainstream lenders.
Pepper Advantage's Credit Intelligence platform transforms real-time global data and analytics into valuable information, so that you can make insight-driven decisions to benefit your business and your customers’ financial experiences.
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1 Please note Northern Ireland is excluded due to small sample size.
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