Ray Boulger talks base rate
“The steady steam of rate cuts gathered pace over the month, mostly on fixed rate mortgages. In the last week only one major lender, Woolwich, has moved rates in the opposite direction, as well as reducing its product range; this was no doubt to reduce demand in order to address service issues.
“Comments during the last month from both Deputy Governors of the Bank of England had already sent a strong signal that the MPC would be in a no change mood today, despite the fact that utilisation of the last tranche of Quantitative Easing (QE) has just been completed. The view that further tranches of QE would produce very limited and diminishing benefits is gaining hold. Furthermore a Bank Rate cut would weaken bank and building society balance sheets because of their contractual obligations on long term tracker loans, whilst the minority of borrowers who would benefit from a rate cut are those already paying low tracker rates and who therefore need it least. A 0.25%, or even 0.5%, cut would be most unlikely to persuade mortgage lenders to cut their SVRs and therefore would do little to stimulate spending.
“If, as seems likely, the MPC decides in the first half of next year it needs to stimulate the economy further it will need to come up with something innovative rather than simply more QE or a Bank Rate cut. It should reflect on the fact that it is already clear the Funding for Lending Scheme (FLS) has had a major impact in pushing interest rates down to new lows, with 3m Libor now at 0.53% and 5 year swaps at 1%. Furthermore, it has reduced the supply of new Residential Mortgage Backed Securities (RMBS) as potential issuers can obtain cheaper funds by tapping the FLS instead, with similar collateral.
“The lack of new RMBS issues, with investors’ appetite for this type of security improving as they increasingly recognise the very strong performance of prime UK issues, has pushed yields down in that market, benefiting even those lenders who don’t qualify for access to FLS by allowing them to raise funds through an RMBS issue at a lower cost, as evidenced by last month’s issue from Paragon.
“Despite the success of FLS, the major benefits in terms of increased lending will come through in 2013 and I expect gross mortgage lending to increase to around £155bn next year. However, because FLS is not targeted, and because of the very high capital requirements for higher LTV lending, it is unlikely to have much impact on the volume of mortgage lending at higher LTVs – 85% and 90%, let alone 95%, although it has had an impact on the rates at which some of these mortgages are available. The challenge for the Government and the Bank of England is to address the lack of funding available in the high LTV end of the market.
“Building on the success of FLS it is not too early to design FLS2, which would then be available for a quick roll out if required. The mark 2 version could combine offering funds to lenders for a significantly longer term than the 4 years of FLS, preferably at a fixed rate, taking advantage of the Government’s ability to borrow very cheaply. The quid pro quo would be that lenders accessing the scheme must commit to using a significant percentage of the funds to offer high LTV longer term fixed rate mortgages.
“By offering a longer term fix, say 7 – 10 years, at today’s low rates the risk of borrowers defaulting as a result of an increase in interest rates would be negated. In addition, as all these mortgages would have to be on a repayment basis the LTV at the end of the fixed rate period would have fallen far enough to mean that the risk of loss to the lender at that stage was very small. Even the problem of high early repayment charges (ERC) on long term fixed rates could be addressed as the interest rate on such mortgages would be sufficiently low to mean that there would be negligible opportunities for borrowers to remortgage at a cheaper rate and so the mortgages could be offered with no ERCs.
What Should Borrowers do now?
“With the outlook for interest rates continuing to be benign for several years, at first sight there seems little merit in buying a 2 year fixed rate mortgage as it only provides interest rate protection for a period when it is very unlikely to be required. However, many 2 year fixed rate mortgages are now cheaper than tracker or discount rates and hence for those borrowers who don’t want to be locked into ERCs tor too long a 2 year fixed rate can be a good choice. It can also be a good strategy for borrowers needing a high LTV providing they choose a lender with one of the cheaper SVRs to revert to, as most lenders revert their borrowers to the same rate regardless of LTV.
“Sub 3% 5 year fixed rate mortgages are now offered by several lenders up to 60% LTV but competition is also hotting up at higher LTVs. The widely held perception that FLS is only helping those with a 40% deposit is no longer supported by the facts. To demonstrate this the best 5 year fixed rates at higher LTVs are:
75%: 3.29% with a £995 fee (Accord)
80%: 3.79% with a £999 fee (Metro Bank)
85%: 4.49% with a £999 fee (Nationwide)
90%: 4.79% with a nil fee (RBS / NatWest – FTB only)