Mortgage Rates: How Low Will They Go?
Introduction
The United Kingdom officially entered recession in the final quarter of 2008, and the Bank of England has been forced to make cumulative cuts in the Bank Rate – from 5.0% in October 2008, to just 0.5% in March 2009 – in an effort to arrest the economic downturn. The Bank Rate currently stands at its lowest level since the foundation of the Bank of England in 1694 and this is, of course, good news for borrowers with interest-only mortgage loans, who have seen their monthly repayments reduced by 90% in recent months. However, not all High Street lenders are liable or willing to pass on any further cuts in the Bank Rate to borrowers, and the Governor of the Bank of England, Mervyn King, has stated that he does not believe the Bank Rate will fall below 0.5%, in any case. Furthermore, history shows us that soaring Government borrowing – a record £75 billion in current fiscal year – leads to higher interest rates in future and, according to Lord Turner, chairman of the Financial Services Authority (FSA), mortgage rates can remain high for anything between six and nine years in the aftermath of a banking crisis.
Mortgage Rate Considerations
The global financial crisis has, of course, affected lenders as well as consumers. Lenders need to rebuild their reserves in the wake of the crisis, and cover their costs, but face increased pressure from the Government and industry regulators to protect themselves against bad debt for example, and increased costs. The Financial Services Compensation Scheme (FCSC), for example, imposes a levy on its members, based on the size of their retail deposits, to spread the cost of failed banks across the industry.
Following the 0.5% cut in the Bank Rate in February 2009, just 33% of lenders cut their Standard Variable Rate (SVR), and even fewer seem likely to pass on the subsequent 0.5% cut in March. So, although those borrowers with variable rate or tracker mortgages have seen the benefits of cuts in the Bank Rate, these products constitute just 40% of the total mortgage market and borrowers do not necessarily see interest rate cuts passed on in full.
Some lenders impose a so-called "collar" – typically 2% or 3% – below which the interest rate of their tracker mortgage products cannot fall, regardless of cuts in the Bank Rate. Tracker mortgage deals have become very popular in recent years, but now come with a much higher margin above the Bank Rate – typically 2.75%, for those borrowers with a 40% deposit, or 3% otherwise – than was once the case. There are, of course, some tracker mortgage deals which were available just 12 months ago, which allow borrowers to pay the Bank Rate minus, rather than plus, a percentage.
In the absence of a collar, this introduces the possibility of "negative interest" – where, at least in theory, interest would be paid to mortgage borrowers by lenders – and the FSA has made it clear that, in such circumstances, lenders would be forced to honour mortgage contracts. Lenders without collars have been similarly insistent that no interest would actually be paid in these circumstances. Borrowers would not be liable to pay any interest – so, by definition, anything at all in the case of an interest-only mortgage – while the tracker rate remained at, or below, 0%, and required to repay only capital. Negative interest is highly unlikely, but not completely unprecedented; in Switzerland in the Seventies, banks actually charged foreign customers to hold their money in Swiss francs, rather than paying them interest.
Mortgage rates for short-term tracker deals are unlikely to fall, but as the Government embarks upon its programme of so-called "quantitative easing", the reduced yield on longer term Government bonds will make longer term, fixed rate mortgage deals – such as those over five or ten years – more affordable. Quantitative easing – sometimes referred to incorrectly as "printing money" – is a process whereby a central bank, in this case the Bank of England, creates money electronically in its own accounts, and uses that money to buy company and Government bonds (a.k.a. "gilts") from commercial banks. The value of transactions is credited to the banks, as with any purchase, and the increased funding is made available for loans, boosting the wider economy. Indeed, the Bank of England quantitative easing strategy, which will put an additional £75 billion into circulation, was broadly welcomed by the Association of Mortgage Intermediaries (AMI), despite being untried in the U.K.. However, similar measures were implemented, with limited success, in Japan at the turn of the century.