The banks’ hands are tied on mortgage rates

With a charge sheet that runs from applying rip-off fees to triggering a global economic meltdown, it is little wonder that banks have come in for so much stick lately.

But while much of the criticism has been fully deserved, there is one accusation, repeated again this week, that has been grossly exaggerated.

Despite what many people believe, the simple fact is that lenders are not profiteering from mainstream residential mortgages.

The case against banks and building societies is superficially appealing. The official cost of borrowing, as determined by the Bank of England base rate, is only 0.5 per cent, while Libor (the London Inter Bank Offer Rate), which is the average wholesale cost of funds to the banks is not much higher at 1 per cent. At the same time, the cost of the average two-year fixed-rate mortgage is 5.23 per cent and the average rate on a two-year tracker deal is 4.74 per cent. Two years ago, shortly before the credit crunch started, the difference between Libor and the average two-year fix was only 0.31 percentage points. Now the gap has widened to 3.86 points. But this simplistic analysis does not tell anything like the whole story.

For a start, Libor is only an average rate — the actual wholesale cost of borrowing for most lenders, particularly building societies, is much higher. There are also many other costs that lenders are now incurring that did not exist one or two years ago.

For example, banks and building societies now have to pay an increased levy to the Financial Services Compensation Scheme for bailing out savers who had money deposited with institutions that have since collapsed, such as Icesave, the Icelandic bank, and Dunfermline Building Society.

Lenders are also making bigger losses on bad loans as the recession bites, as well as having to fund cheap mortgages linked to the Bank of England base rate. Then there is the cost of the government guarantees that are required to raise finance in bond markets.

Perhaps more importantly, however, comparisons between wholesale borrowing costs and residential mortgage rates are less relevant now that lenders increasingly use savers to fund their home loans.

The freezing of wholesale money markets means that most banks, and all building societies, now raise the majority of their funds through retail deposits — and they are having to pay handsomely to do so. There are now five separate fixed-term savings accounts paying more than 5 per cent, well in excess of the Bank of England base rate.

A good example is Yorkshire Building Society, which relies on savers to fund approximately three quarters of its mortgages. The Bradford-based mutual is currently offering a two-year fixed-rate saving bond with a rate of 3.5 per cent. Borrowers (with a 40 per cent deposit) can get a two-year fixed-rate mortgage with the same society at 4.29 per cent, a difference of only 0.79 percentage points. When you take into account all the aforementioned costs, this does not look anything like profiteering.

The graph above illustrates this trend across the wider market, with the gap between average savings accounts and best-buy mortgage rates remaining fairly steady over the past two years.

Of course, that is not to say that banks and building societies’ lending practices have been perfect over the past 12 months. Far from it. The cost of loans for borrowers who are perceived not to be a perfect lending risk has risen far beyond what is reasonable. In many cases, lenders have been overcautious. In others, borrowers have been treated shabbily.

Almost every week another example of poor conduct emerges. Last week it was Nationwide offering existing customers a poor-value one-year fix. This week it was Northern Rock trying to persuade customers to switch deals, which could mean that they incur thousands of pounds of early redemption charges only months before their existing deals expire.

But while individual lenders can be criticised for much, the industry as a whole is, on balance, being unfairly maligned over the margins that it makes on mortgages.


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Studlea and the Art of Debt Consolidation

There has been far more activity in the financial world over the last couple of weeks than many will have seen in the news, mainly because it is difficult for the journalists to make bad news out of it. It's a shame really, because there is a fair bit of bad news if only they realised it, but more of this next time.

Before getting into all that, a few quick snippets.

Interest Rate Sweepstake

Please let me have your selection as to which month you think interest rates will rise. As widely anticipated there was no change in July, so our sweepstake is now pick 1 from 11. When do you think interest rates will first increase? You can choose any month from August through to June next year. (Consensus so far is around November to January). A prize to all who pick the right one.
Studlea Update

He walks! Wobbly, and not very far, but very definitely walking although a polished floor still produces a four legged feline version of the splits, and obviously, he still blames me when he falls over, even if I'm the other side of the room. This improvement is some weeks later than the surgeon anticipated, but with suitable irony, the surgeon himself explained he was having a minor surgery and would be off work for a week. That was nearly three weeks ago...
Debt Consolidation

Over the last few weeks, I have had conversations with several different families who are under the weight of an array of borrowing arrangements, including mortgage, loans, credit cards and so on. The theme is the same; a desire to reduce outgoings but there is a right way and a wrong way. I would venture however, to be burdened with debt in modern society is not a failing of the family in most cases, but a failure of government and regulators who forced house prices up and allowed lenders to over extend their customers.

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