British homeowners and small businesses are facing a fresh credit crunch as the fallout from the Iran crisis ripple through the financial system. The Bank of England reports the biggest rise in mortgage defaults in more than a year.
The bank’s latest credit conditions survey, which measures lenders’ appetite and demand for new loans, showed that defaults on secured loans, mainly residential mortgages, rose to 6.2 percent in the first three months of 2026. That’s the highest since the final quarter of 2024, when defaults peaked at 7.8 percent following a series of rate hikes by Threadneedle Street.
Unsecured lending was even murkier. Defaults on credit cards, personal loans and overdrafts rose for the fourth quarter in a row to 18.6 percent, the highest level since the final months of 2023, when the figure was 25.7 percent. Overall, the data suggests that household finances, which began to stabilize in the second half of last year, are again under serious strain.
According to the bank’s report, demand for home loans and other forms of credit remained buoyant in the run-up to the conflict, supported by a steady decline in borrowing costs. This brief window of optimism has now closed. Since hostilities escalated in the Middle East, lenders have quickly reassessed the risk, raising the average interest rate on two-year fixed-rate mortgages from around 4.8 percent to more than 5.5 percent in a matter of weeks.
For a typical borrower with a £200,000 mortgage, this shift means around £1,000 more per year in repayments, a sum that few overstretched households can comfortably absorb on top of the stubborn food and energy bills.
Raj Abrol, managing director of venture platform Galytix, said the pain radiated far beyond the front doors of British homeowners. “What began as a conflict in the Middle East is now showing up in borrowing costs across the economy,” he said, warning that the turmoil had “spooked” the country’s major banks and triggered a spike in mortgage prices.
Mr Abrol warned that defaults were likely to increase for several more months as inflation proved stubborn and the cost of living crisis continued. He argued that access to credit is becoming “more of a challenge for consumers” and the small businesses that depend on them as lenders retreat behind stricter lending standards.
The deeper concern, he added, lies beneath the surface of the headlines. The cost of short-term corporate borrowing has more than doubled for lower-rated companies since the end of February, investment-grade bond spreads have widened by 15 basis points and British government bond yields briefly touched 5 percent for the first time since 2008. It reaches employers juggling payroll, SMEs looking to refinance, and consumers whose credit card fees and car financing offers are quietly rising.
With almost a million fixed-rate mortgage contracts expiring by September and inflation trending back towards 3.5 per cent, Mr Abrol warned that defaults risked moving from “a slow crawl to something banks need to take seriously”.
Kenny MacAulay, managing director of accounting software platform Acting Office, expressed similar caution from the perspective of the UK small business community. He said rising inflation and higher interest rates against a backdrop of a stagnant economic outlook would “bring new misery to homeowners and businesses alike” as long as the Iran crisis continued. In such an environment, he argued, building additional reserves and liquidity buffers is no longer optional but essential for any owner-manager who wants to keep the wolves from the door.
For SMEs already struggling with weaker consumer demand, tighter trade credit and rising labor costs, the bank’s survey is an unwelcome reminder that geopolitical shocks rarely stay in the headlines. They ultimately end up on the balance sheet with interest.
