British homeowners and small businesses are facing a new debt crisis as the fallout from the Iran crisis affects the financial system, with the Bank of England reporting the sharpest rise in mortgage defaults in more than a year.
The latest Bank of Credit Survey, which measures the appetite of lenders and the level of demand for new loans, showed that defaults on loans, especially residential loans, rose to 6.2 percent in the first three months of 2026. Threadneedle Street.
Unsecured loans tell a sad story even now. Defaults on credit cards, personal loans and overdrafts rose for the fourth quarter in a row to 18.6 percent, the highest rate since the closing months of 2023, when the figure stood at 25.7 percent. Taken together, the data suggest that domestic currencies, which had begun to stabilize in the latter half of last year, have once again come under severe pressure.
According to the Bank’s report, demand for mortgages and other types of credit remained strong during the conflict, helped by a slight retreat in borrowing costs. That brief window of hope has now closed. As conflicts escalated in the Middle East, lenders quickly cut back on risk, pushing the two-year mortgage rate from around 4.8 percent to more than 5.5 percent in a week.
For the average borrower with a £200,000 loan, that change translates into around £1,000 more a year in repayments, a sum few families can comfortably afford on top of stubborn food and energy debts.
Raj Abrol, chief risk officer of Galytix, said the pain was coming from outside the front doors of British homeowners. “What started as a conflict in the Middle East is now emerging in the cost of borrowing across the economy,” he said, warning that the turmoil had “stumbled” the country’s biggest banks and caused the cost of borrowing to rise.
Mr Abrol warned that deficits are likely to continue to rise for some months, as inflation continues to stick and cost of living problems continue. As lenders push back on tighter underwriting standards, he said, access to credit will be a “big challenge for consumers” and the small businesses that rely on them.
The deeper concern, he added, lies beneath the headline numbers. Short-term corporate borrowing costs have doubled for low-rated companies since late February, the spread on investment-grade debt has widened by 15 basis points, and UK gilt yields briefly touched 5 percent for the first time since 2008. It filters through to employers using their paychecks, SMEs hunting for financing, and consumers whose credit card rates and car finance deals are quietly increasing.
With almost a million mortgages due to expire in September and inflation back to 3.5 per cent, Mr Abrol warned that defaults risked moving from “a slow move to something the banks have to take seriously”.
Kenny MacAulay, chief executive of accounting software platform Acting Office, warned similarly from the perspective of Britain’s small business community. He said rising inflation and higher rates, compared to a sluggish economy, “will bring misery to homeowners and businesses alike” as long as the Iran crisis continues. In such a situation, he argued, building additional cash and cash buffers was no longer an option but essential for any owner-manager hoping to keep the wolves at the door.
For SMEs already grappling with weak consumer demand, tight trade credit and rising wage bills, the Bank’s survey is an unwelcome reminder that global shocks rarely remain headline-grabbing. They end up sitting, with interest, on the balance sheet.
