Long shot
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Fast-forward five years - Brown is now Prime Minister and long-term fixed rates are once again making headlines but this time over fears that they are rapidly disappearing.
Since the credit crunch gripped the world consumers have become more aware of risk. When times were good lenders and consumers enjoyed the availability of easy credit short-term deals made sense.
Borrowers could take out two-year fixes with great rates safe in the knowledge that once their products expired they could remortgage onto equally impressive rates.
But since the collapse in the value of US homes two years ago and the global market meltdown that ensued, everyone is aware of how volatile the housing market can be.
So now many consumers want stability - to know precisely what they owe and what they are paying. An answer for some borrowers could be long-term deals. But the potential demand has not been matched by supply and indeed, in the past few months the number of long-term deals on the market has fallen.
Just last month Manchester Building Society became the latest lender to axe some of its longer term products including its 30-year fixed deal. The longest fixed rate currently available is for 15 years.
So why are lenders pulling their long-term products despite the benefits some borrowers might derive from them?
It was in 2003 that Brown commissioned Miles - now a member of the Monetary Policy Committee - to look into why long-term fixes weren't as popular in the UK as in the US.
Miles came up with three reasons why consumers here were turning their noses up at long-term fixes. The first was that borrowers tended to attach greater importance to the level of initial monthly repayments than to the overall cost of borrowing over the life of the loan.
Second, he argued that many borrowers had a poor under-standing of risk and therefore paid little attention to the insurance that longer term fixed rate mortgages could provide against unexpected interest rate rises.
And finally he attacked the way many lenders competed for new business, resulting in cross-subsidisation by existing customers paying SVRs that funded new borrowers taking outdiscounted variable and short-term fixed rate mortgages. As a result, longer term fixed rate mortgages appeared expensive compared with discounted deals.
His recommendations to boost the take-up of long-term deals included lenders making their full ranges of products available to all borrowers. He also suggested that brokers could help consumers assess risk by presenting them with 'what if' scenarios to give an indication of the scale of variability in interest rates.
"The notion that any shift away from the type of lending that has been common in the past few years will be bad for new borrowers is mistaken," Miles said at the time. "In fact, the advantages of the insurance given by fixing the interest rate on borrowing for several years are likely to be greatest for those who borrow a lot and for whom income risks are large - a group likely to contain a high proportion of first-time buyers."
But while a couple of lenders introduced long-term products they found a largely unreceptive audience. Brown has kept plugging away at them though, and when he took the helm as Prime Minister in 2007 one of his first pronouncements concerned the need for more long-term fixed rates. He unveiled a revised regime for covered bonds to help mortgage lenders finance more affordable 25-year fixed rate products.
Following this announcement several lenders stepped up to the plate offering 25-year fixed rate deals including Cheshire Building Society and Kent Reliance Building Society.
These pioneers were followed by the likes of Nationwide and Halifax. Could it be that the take-up of long-term fixed rates was finally picking up momentum? Alas, the small matter of a global economic meltdown spoilt the party and we never found out.
When the credit crunch took hold working out which products were most advantageous was put on the back burner as many consumers struggled to get any deals at all. And as liquidity dried up lenders wanted faster returns.
"Lenders are reluctant to offer long-term fixed rates due to the volatility of the money markets," says Darren Cook, mortgage expert at Moneyfacts. "Shorter term funding is being allocated to mortgages while lenders rebuild their savings books."
As Mortgage Strategy went to press the only long-term deal available was a 15-year fixed rate starting at 6.49% courtesy of Britannia Building Society.
But despite the dearth of products, in terms of improving the way consumers manage risk, long-term deals have much to recommend them. When Miles published his report he advocated more clarity about the risks associated with different types of mortgages as borrowers tended to focus excessively on the initial monthly cost of deals.
And just last month Lord Adair Turner, chairman of the Financial Services Authority, questioned whether there was too much innovation in certain markets with complexity acting as a possible barrier to understanding. So are simple longer term fixed rate mortgages the answer?
In his 2004 report Miles noted the correlation between an unsettled economy and the demand for longer term fixed rates.
"When there is a significant positive correlation between inflation shocks and real interest rates households would prefer long term fixed rate mortgages at any loan-to-income ratio above about three," the report stated.
Cook says the current market has seen Miles' observation proved correct.
"Fixed rates came under the spotlight when, just after the first of six Bank of England base rate cuts last October, providers quickly withdrew the majority of their tracker rate mortgages and relaunched seriously slimmed down ranges resulting in half the supply disappearing before returning at a premium price," he says.
"Consumers who were witnessing the lowest base rates in history were expecting fixed rate mortgages to follow suit and become cheaper. This would have been the perfect opportunity for consumers to fix their mortgages for the longer term in anticipation of the base rate returning to 3% or 4%.
"But instead of this, due to a number of factors including the increased probability of default and complicated funding issues, lenders hiked their margins and since then rates have been disjointed from normal market barometers," he adds.
Cook says that although the cost of fixed rates is high they still account for the largest proportion of demand.
"Fixed rates are generally a safe bet for consumers," he says. "Affordability is assured when making the first payment and after that the same payments are maintained throughout the life of the deal. And in theory repayments should become more manageable as income increases over the years. Only a change for the worse in a customer's financial circumstances should cause a problem."
Of course, while consumers may benefit from long-term fixed rates one section of the market would not - mortgage brokers.
Current market circumstances - which mean reverting to a lender's SVR as opposed to remortgaging is common - have been detrimental to brokers' livelihoods.
It is obvious then that if most consumers opted for fixed rates of 25 years or more a large proportion of brokers' services would be rendered redundant. That's why it's understandable that brokers are reluctant to offer such products.
"Brokers have no incentive to sell these products even if they were competitively priced, which they are not," says Richard Campo, technical adviser at Alexander Hall. "The intermediary role would become transactional rather than ongoing,"
"If lenders switched to paying trail commissions on long-term fixed rates that might change broker behaviour but as things stand the products are poor and advisers would lose out. Without a fundamental change in the market these loans simply won't work."
Despite the obvious attractions of longer term fixed rates for consumers the majority of brokers Mortgage Strategy has spoken to do not believe they will become a significant feature of the market.
The main objection is that certain features of these mortgages that some consumers may not be aware of make them more complicated than regular deals. Many brokers also believe that despite the stability long-term loans can offer consumers will always be reluctant to commit for an extended period.
"Many lenders have tried to offer these deals but we've always found clients prefer shorter commitments," says Danny Lovey, proprietor of The Mortgage Practitioner. "Unless a provider can guarantee not to impose early repayment charges if deals are repaid that situation is unlikely to change. Someone has to bear the interest rate risk over 25 years and if lenders did this the cost would be high for borrowers."
Lovey says some lenders have tried to offer shorter deals of, say, 10 years with the option to extend these to 25 years but it's difficult to recommend such products to clients unless they want to commit for that long and are not put off by ERCs.
"An adviser has to be convinced it is right for their client to fix for such a long period," he adds. "In many cases it could amount to mis-selling if a broker recommends a long-term fixed rate and it turns out to be inappropriate for a client's needs."
Of course, lifestyles in the noughties are different from those of past decades. Families and relationships are not always long-term, so should mortgages be?
Changing lifestyles mean there is little demand for long-term products, according to Peter Curran, head of intermediaries at Lloyds Banking Group.
"Personal circumstances can change significantly over such long time periods," he says. "When we have offered 25-year and 10-year products in the past but there has been little appetite for them.
"These are niche deals for a select number of borrowers. Indeed, we've noticed that a significant number of the borrowers who take them out switch deals before the term is up."
So longer term deals are not a blanket solution. If only a select number of consumers benefit from taking out long-term products advocating them to borrowers as the one-size-fits-all product for the future is hardly likely to work.
But the one-size-fits-all long-term approach is indeed being considered in the US. President Barack Obama has spoken of his plan to revamp financial regulation in an attempt to protect borrowers from "confusing and high risk mortgages". Obama is advocating vanilla mortgages - simple, long-term loans without complicated features.
But the US market is markedly different from ours and most professionals in the UK financial sector agree that Obama's approach would not work on this side of the Atlantic.
"A one-size-fits-all approach is unlikely to work for UK borrowers," says Campo. "Financial advice is often as complicated as clients are so a simplistic and generalised approach may be a good idea for the US.
"But in practice these deals do not work well over here as we tend to have heavy ERCs for the duration of loans which could make life difficult if clients wish to move home or borrow more as their circumstances change."
Richard Morea, technical manager at London & Country, says UK consumers would not be happy with the lack of choice vanilla mortgages would provide.
"Borrowers in this country have been well served in the past by a wide choice of mortgages," he says. "Unless lenders radically improve product design any move towards limiting that choice will be unpopular and to the detriment of borrowers."
Mortgage Intelligence this year offered a 20-year fixed rate mortgage at 4.99% up to 75% LTV from Stroud & Swindon Building Society brand In The Loop Mortgages. The product has an ERC that reduces over five years from 5% in year one to 1% in year five and is 0% for a month on every subsequent five-year anniversary of the deal.
Sally Laker, managing director of MI Holdings, says long-term fixes can work if there is a break-out clause every three or five years to enable clients to exit without penalties, albeit in a four-week window.
"Also, for advisers to do a good job with regard to Treating Customers Fairly they should revisit clients every time the break clause comes up to reassess if the product is still the most suitable and receive a proc fee for doing this," she says. "Given these condition longer term fixes can work, as we proved with the ITL Mortgages product we piloted."
One of the main reasons long-term deals are not so common here is the difference in the way mortgages are funded in the US. Across the Atlantic loans are guaranteed by government agencies, cutting the risks to the banks involved. Longer term fixed mortgages are sold into the government-backed vehicles Fannie Mae and Freddie Mac which in turn issue long-term bonds into the markets.
"Having clients stuck on their books for 25 years is unappealing to lenders in the UK," says Campo. "Without loans remortgaging elsewhere they are not freeing up new capital to lend. And further restricting funds at the moment could kill off the tentative housing recovery we are experiencing."
Nigel Quinton, chief executive of Mansfield Building Society, agrees.
"Selling longer term fixed deals is problematic as business flows are uncertain and the acquisition and utilisation of supporting derivatives is difficult to manage in volatile times such as these," he says. "Matched funding would be difficult to source as investors want relatively short fixes."
The costs don't work out too well for consumers at the moment either, according to Alison Beech, business relationship director at Spicerhaart.
"The disparity between long-term money market rates and short-term rates is huge," she says. "Longer term rates are high despite the base rate being low. Longer term fixed deals are simply not economic while this disparity continues."
Michelle Ainge, mortgage adviser at Jackson King, part of Perspective Financial Group, also picks up on the uncompetitive nature of the rates on offer.
"For borrowers who want the certainty that they can afford their mortgage not only when it is first taken out but throughout the term, fixed rates could look attractive," she says. "But with 15-year fixed rates priced at around 6.5% products will have to be considerably more competitive before I'll be convinced they are not too expensive."
Most lenders insist that it's more important to offer choice and competitively-priced products than to try to push longer term deals.
"We want to offer customers one of the widest product ranges in the market but it still needs to make commercial sense," says Curran. "The cost of securing funding for such a long period, especially in a market where funding is as restricted as it is, makes it hard for banks to price these products competitively enough to attract borrowers."
After two years of financial turbulence that has brought the market to its knees it is no surprise that everyone is scrabbling around to find a solution.
Longer term fixed rates may form a part of that solution but lenders must first make the products more appealing. Until funding returns and offering them becomes beneficial to lenders, that seems unlikely.
Consumer demand remains low
Richard Barker Product Manager Norwich and Peterborough Building Society
A principal factor in the decline in the availability of longer term fixed rate mortgages is customer demand. Following the fall in the Bank of England base rate to a historically low level the disparity between the best variable rate deals and best fixed rates has increased.
Rates on fixed deals are now higher given the expectation of future rises in interest rates whereas most variable rates are linked to the base rate or lenders' SVRs.
But many mortgage customers are keen to secure the lowest rate and the spectre of future interest rate rises does little to deter them from opting for variable rates, particularly when the monetary difference can be several hundred pounds per year. The best 10-year fixed rate currently stands at 5.49%, markedly higher than the best variable rate deals at around 3%.
Furthermore, since the start of 2009 the yield curve has become steeper which has resulted in the differential between short-term and long-term swaps - the rates that lenders use to price fixed rate mortgages - diverging.
In December 2008 the difference between two-year and 10-year swaps was around 0.8% but now that gap has widened to 1.9%. This means that 10-year fixed rates are considerably less attractive than two-year fixes.
So a mortgage borrower in the market for a fixed rate is more likely to choose a shorter term deal than a longer term one given the likely differential of at least 1.5%. Previously, the rate gap between short and long-term fixed rates was much smaller which probably tempted more fixed rate borrowers to consider taking out longer term products.
Also, during times of economic uncertainty many borrowers prefer to have a degree of flexibility in their mortgage products so they are not tied into a deal if their circumstances change.
But the fall in the availability of longer term fixed rates is not all down to consumer demand. There are also supply issues that might have led to some lenders withdrawing from the market. The credit crunch and its impact on wholesale money markets has resulted in lenders finding it more difficult to obtain wholesale money to fund their mortgage lending.
With funding more scarce many have adopted a cautious stance when it comes to the products they are prepared to offer and who they will lend to.
So while more lenders would undoubtedly enter the long-term fixed rate market if consumer demand increased this is unlikely to happen in the current environment for the reasons outlined above. Consumer demand is unlikely to pick up until interest rates start to rise and we see some convergence between variable and fixed rates.
25-year fixes are unpopular but deals of five or seven years could work
David Whittaker Managing Director Mortgages for Business
The last significant pilot scheme in the area of long-term fixed rates was initiated by Bear Stearns in 1992, offering deals lasting up to 25 years. The company recruited around 25 staff to run the scheme, set out its stall and waited. And waited.
Longer term fixed rates were used in the commercial market by Norwich Union and Eagle Star in the past as funding for government gilts but there were problems. Eagle Star wanted an endowment policy or a pension scheme with its own brand which was expensive.
But NU took a different approach and is still a big provider to professionals, especially doctors and dentists. These schemes have exit fees based on the mismatch of gilt rates to the original cost multiplied by the loan amount and the remaining period. This could amount to 20% or more of the loan amount and represents an uncapped risk.
25-year fixes are unpopular but deals of five or seven years could work
Bill Warren Managing Director Bill Warren Compliance
Mortgages of 25 years are generally unacceptable to consumers accustomed to being offered a choice. Few borrowers buy houses expecting to remain in them for 25 years. Usually they think in terms of 10 years to get the kids educated, then either move on or downsize.
In these uncertain times flexibility is even more important. This is likely to dissuade borrowers from considering long-term commitments.
But if the definition of long-term is five or seven years, that's a different matter. Given reasonably competitive rates, for many consumers fixes of this sort of duration could appeal.
The concept of fixed payments to enable efficient financial planning has always been attractive but to remove freedom of choice when it comes to the biggest purchase most consumers will ever make could be seen as a threat to their human rights.
With some imagination lenders can make longer term deals appealing.
Linda Will Sales and Marketing Director In The Loop Mortgages
It seems like only yesterday that Professor David Miles was suggesting that the way to avoid spiralling house price inflation was to adopt the US model of longer term fixed rate mortgages. Back in 2004 he met with resistance on all sides. Brokers protested that their customers wanted short-term fixes and continued to recommend them.
Lenders, competing viciously for market share, had little incentive to buck the trend. Heavily broker-led and with a vested interest in not biting the hand that was feeding them they faced margins that were paper thin so why should they lock in at scarcely above break-even?
Although we refused to follow the US down the long-term fixed rate road we were unable to avoid following it into a mortgage meltdown. Even if the credit crunch had not suffocated money supply the number of consumers unwilling to sell their homes at what they considered to be a loss would have brought the market to its knees anyway.
So what about borrowers on shorter term fixed deals? No doubt some have been green with envy reading about low tracker rates. Other deals have matured onto relatively low SVRs and borrowers are likely to stay put until they see an upward move in the base rate.
Interestingly, some brokers feel that low tracker rate payers would only consider moving to other trackers with the benefit of caps.
So are long-term fixes now even more anathema to borrowers than before? Not if a bit of imaginative thinking is brought to bear.
We recently launched a 20-year fixed rate through Mortgage Intelligence at just under 5% and it sold out in no time. The secret lay in aligning the expectations of brokers, borrowers and the lender. Customers were offered a pay rate lower than had ever been seen over such a long term but they could also walk away at regular intervals without early repayment charges. When rates return to normal these clients will be well placed but still have the reassurance of a safety net.
