Will attractive long-term gilt yields, post-Brexit nervousness and a potential cut in interest rates prompt both lenders and borrowers to commit to longer-term fixes?
The UK’s love affair with fixed-rate mortgages shows no signs of fading. Lenders are wooing borrowers with record-low rates as they vie for attention.
And now that some attractive long-term gilt yields are on offer, will both lenders and borrowers be tempted to make a longer-term commitment?
UK borrowers customarily like to keep their options open when taking out a mortgage, choosing not to tie themselves to a lender for more than two or three years.
Lenders, too, have a passion for such deals. In June, HSBC launched an all-time low two-year fixed-rate mortgage at 0.99 per cent up to 65 per cent LTV, albeit with a £1,499 fee. Several other lenders have also cut their short-term fixes in recent months.
However, lenders are starting to look beyond the short term, with launches of some appealing five- and 10-year fixes. Coventry Building Society, in particular, has set the bar high with a 10-year fixed rate at 2.39 per cent up to 50 per cent LTV, with a £999 fee.
Mortgage Advice Bureau head of lending Brian Murphy says fixed rates have fallen substantially over the past few years.
“A typical two-year fix has come down by over 20 basis points in the past 12 months and by over 60 basis points over the past 18 months, as have five-year fixed rates,” he says.
Meanwhile, John Charcol senior technical director Ray Boulger says long-term gilt yields have been the most affected by Brexit and have fallen more than their short-term counterparts.
“The spread between five- and 10-year gilt yields has narrowed,” he says. “This makes it more viable for lenders to offer a 10-year fix because they can get a lower rate.”
“On referendum day, 10-year gilt yields were 1.37 per cent; at the time of going to press they were around 0.79 per cent. A fall of around 60 basis points is a huge change in such a short period.
“Some lenders have come in with slightly cheaper longer-term rates but they still reflect only a third of that fall. Other lenders in the long-term fixed market have scope to cut rates and I expect them to do so, but I wouldn’t expect the likes of Coventry to come down again.”
Boulger believes gilts have fallen because the market assumes that the Bank of England base rate will be kept low for longer than anticipated.
“When it comes to the pricing of gilt yields and swap rates, the two key factors are where the market expects rates to go over the short and long term, and inflation expectations – currently 0.5 per cent,” he says.
According to the latest figures, inflation increased in June from 0.3 per cent to 0.5 per cent, attributed in part to the increase in airfares for those attending the European Football Championship in France. It is too soon for the data to reveal the ‘Brexit effect’.
A rise in inflation ordinarily increases the likelihood of a rise in interest rates. However, although the Government’s target is to reach inflation of 2 per cent, its overriding objective in the wake of the Brexit vote is to keep the economy stable, which Boulger says entails a lower base rate.
Swap rates – the rate at which lenders borrow on the money markets – are a good indicator of fixed-rate pricing, often reflecting what happens in the gilt yield market.
Longer-term swap rates have tumbled since Brexit, with two-year swaps around 0.53 per cent compared to 0.72 per cent in mid-June, and 10-year swaps around 0.92 per cent compared to 1.39 per cent just prior to the referendum.
But London & Country associate director of communications David Hollingworth says swap rates fluctuate all the time and are greatly affected by sentiment.
“They can go up and down even when interest rates have not moved at all,” he says. “There’s nothing to say that very low swap rates will not start to move up over time, and as we get more clarity over how things will pan out around Brexit.”
It may be the perfect time for lenders to take advantage of the cheap funds on offer but are their hearts really in it?
“I’m not sure,” says Hollingworth. “It has not happened yet and some lenders are perhaps not going to be in a rush to beat HSBC’s 0.99 per cent fix, for example.”
It is not just the cost of funds that will dictate lenders’ appetite to cut their fixed rates. Demand from borrowers will also have an influence.
Coventry Building Society mortgage product manager Ian Biggs says: “What happens to short- and longer-term fixed-rate mortgages will depend on many things, not only how the economy develops or the costs of funding but also changes in people’s attitudes and behaviours.
“Fixed-rate mortgages have always been popular with borrowers who value stability and it’s likely that the increase in longer-term fixed products that we’re seeing at the moment reflects the current uncertainty that many feel,” he says.
Spicer Haart and Just Mortgages group operations director John Phillips agrees that consumers are seeking certainty after Brexit and thinks that both long- and short-term fixed rates are likely to continue to fall.
“As confidence continues to grow in the financial markets and among mortgage lenders, we could start to see a raft of lenders coming to market, offering cheaper fixed-rate mortgages in order to pull in the business, which will in turn increase competition,” he says.
Boulger, too, thinks the market will experience more rate-cutting.
“Some lenders haven’t changed rates at all and particularly in the five-year market there hasn’t been much movement. There is definitely scope for more lenders to join HSBC with a sub-2 per cent five-year fixed rate,” he says.
If the BoE cuts interest rates this summer, as widely expected, Boulger thinks lenders would have another incentive to lower their fixed rates.
“Bearing in mind how low savers’ rates are at the moment, if we get a quarter-point cut in the base rate, lenders could cut savers’ rates even further, in which case they would have more scope to cut mortgage rates.”
Rates such as HSBC’s 0.99 per cent two-year fix may seem to tick all the boxes. But if, as with this product, there is a £1,499 fee attached, are such deals as good as they look?
Trinity Financial product manager Aaron Strutt says: “Sometimes the high fees take a bit of explaining. The lowest rate isn’t always the best but typically most people want the cheapest rate.”
Murphy finds some borrowers happy to pay high fees because their motivation stems from the lower monthly payments.
“Others prefer a lower fee or, indeed, no fee at all but the caveat is usually a higher monthly payment. It all depends on client circumstances, requirements and preferences,” he says.
In the past, lenders have tried and failed to ignite the longer-term fixed-rate market. But could borrowers’ jitters over Brexit push them into longer-length wedlock with lenders?
Research by HSBC has found that seven in 10 house-hunters would consider fixing their mortgage for 10 years in order to acquire certainty over their financial outgoings.
Building Societies Association policy adviser Robert Thickett says that, despite the recent availability of attractive long-term fixes in the market, only time will tell if this is the start of an enduring trend.
“Long-term fixed rates have been talked about in positive terms for years,” he says. “In 2004 the then Labour government commissioned and published a report on promoting the take-up of long-term fixed rates, which are a mainstay of other mortgage markets, like the US.”
“However, in the main, UK consumers continue to show a preference for shorter-term deals.
“Part of this is down to the way mortgages are sold, with intermediaries traditionally favouring shorter-term deals. Another factor is that the culture in the UK is not to lock in for the long term.
“Everything in our lives is about the short term, whether that’s contracts with mobile phone and energy providers, or rental agreements.”
Murphy, however, thinks the public’s attitude to five- and 10-year fixes is changing. He says: “In the past couple of years, we’ve seen more buyer sentiment towards longer-term products.”
“For most people, their mortgage is their largest single monthly commitment. So, if they can put a cap on their largest element of household expenditure, it’s reassuring to be able to control their finances, particularly in times of uncertainty.
“Therefore, lenders are becoming more in tune with market demand and responding to it, which is evidenced by the current competitive spate of 10-year fixes.”
Perception Finance managing director David Sheppard says over the past 12 months five-year fixes have been in greatest demand at his firm.
“In a time of historically low rates, the thought of fixing for a long time is just too good to miss for a lot of people,” he says.
“I do not foresee a change in this for some time, and certainly not for trackers. The pricing between fixed and trackers is quite close and, unless the view changes to believe that the base rate will drop to zero and stay there for a prolonged period – which even then would mean lower fixed options in all likelihood – a tracker will not be a risk that many will take.”
However, not all lenders have experienced such demand for longer terms. TenetLime managing director Gemma Harle says:
“There is good demand for fixed rates but primarily for shorter-term loans. The market for a 10-year fix remains very narrow. We have seen no slowdown in business but advisers are getting asked a lot more questions in this period of uncertainty.”
So what puts off some borrowers from locking in for five to 10 years?
“The ERC [early repayment charge] element is one factor that can put buyers off taking a longer deal such as a 10-year fix,” says Murphy.
“There is always caution around ‘What happens next?’ if they need to move due to lifestyle change, so planning further than five years in advance can be more challenging for most people,” he says. “Therefore it’s likely that more lenders will introduce products similar to what TSB has done, with ERCs for the first five years only of the 10-year fixed-rate period.”
Boulger thinks ERCs are in lenders’ hands.
“Some lenders have addressed the issue of ERCs very well, others very badly,” he says. “Coventry’s 10-year fix, for example, has an ERC of only 1 per cent in the final five years. This compares to Santander, which has a 10-year fix at 2.94 per cent but with a 6 per cent ERC for the whole 10 years. If a borrower is redeeming in the last two years, their ERC will be more than the total outstanding interest.”
Boulger also expresses surprise that more lenders have not taken advantage of the Mortgage Market Review ruling that allows five-year fixes to have softer stress tests.
“I don’t think most of them are taking this opportunity at the moment,” he says.
According to MMR regulation, lenders must stress-test would-be borrowers based on a 3 percentage point rise in Bank rate on top of their SVR, but this applies only to fixed-rate deals of up to five years.
“On a 10-year fixed rate, it’s perfectly plausible from a regulatory point of view for lenders to have a softer affordability test and therefore offer a higher maximum loan,” says Boulger.
“But I’m not aware of any lenders doing that. Precise Mortgages has a six-year fix where it calculates affordability on the pay rate. But I think it’s a missed opportunity by lenders.”
He adds: “The BoE has said it is concerned that when interest rates go up this will put people under more financial pressure.
The obvious answer is to encourage people to take longer-term fixed rates. If lenders applied a softer stress test, it could encourage people to switch to a 10-year fix.”
BIG LENDERS OR SMALL?
If both short-term and long-term swap rates continue to fall, which lenders will be bold enough to make the move? Building societies are holding their own against some of the banks.
“HSBC is a big global bank with access to good funding lines but, equally, Yorkshire Building Society tends to price very sharply,” says Hollingworth.
Harle notes that building societies tend to be more willing than banks to offer fixed rates at higher LTVs. She adds: “If interest rates do drop, however, savings will be further impacted and funding could potentially become an issue across the board.”
Boulger believes it all comes down to lenders’ pricing models. “Different lenders calculate costs in different ways,” he says.
“For some lenders it’s difficult to be competitive in the low-LTV market. Smaller building societies rarely have the most competitive rates at low LTVs but they are often very competitive at higher LTVs and that’s all about capital adequacy requirements. As smaller lenders, they are assessed in a different way and that can make it difficult for them.
“Likewise, some of the smaller lenders are much more restricted than the larger lenders in terms of the proportion of their lending that can be done at fixed rates. The different regulatory requirements have an impact on the areas in which lenders can be competitive.”
Even when a lender has the ability from a regulatory point of view, says Boulger, it also needs to consider its existing mortgage book and what it wants to prioritise in order to balance it.
Record-low interest rates are an effective means of grabbing the headlines and keeping other lenders on their toes. But is there a risk of lenders and borrowers playing a game of cat-and-mouse?
“Borrowers could end up waiting for these falling rates,” says Hollingworth.
“I think we will get more lenders being more competitive but, unless they start absolutely slashing rates, there is a danger that borrowers will just wait and wait, and it may save them only five basis points.”
A BoE cut in interest rates, however, could persuade more borrowers to commit themselves to longer-term fixes. And a combination of lower rates and ERCs from lenders, coupled with borrower uncertainty over Brexit, may provide the trigger.
“Borrowers know at least that, with all the uncertainty in the economic market, they have record-low fixed mortgage rates,” says Hollingworth. “That is something on which they can pin some certainty.”
What will make consumers choose longer fixes?
Sue Anderson, head of member and external relations, Council of Mortgage Lenders
Around half of existing mortgages are on a fixed rate and around 90 per cent of new mortgages are written on a fixed-rate basis.
This has been the case for the past couple of years but was not always so. Our data shows that, in 2012, fixed-rate loans accounted for less than 70 per cent of new lending, while in 2008 the proportion was less than 60 per cent and in 2004 less than 40 per cent. The rise of the fixed rate as the product of overwhelming choice is therefore a relatively recent phenomenon.
Beneath the headline data, it is not hard to see why. In May, the average fixed rate taken out was 2.56 per cent – a fraction above the average discounted rate of 2.51 per cent and well below the average SVR of 2.81 per cent.
Compare this with 2012, when the average fix was 4.01 per cent against an average discounted rate of 3.4 per cent and an average SVR of 3.43 per cent.
But what will happen if there is a shift in interest rates or relative pricing dynamic? This is especially relevant given that the bulk of fixed-rate mortgages are still taken out for relatively short periods.
Although there has been a notable rise in both the availability and take-up of products fixed for over five years, a swathe of fixed-rate lending remains concentrated in one- and two-year periods. This is perhaps surprising given the very favourable conditions and rates at which it is possible to secure a lower-for-longer mortgage deal.
It is unclear if the continuing preference for the short-term end of the fixed-rate range is driven by price sensitivity, perceived concerns about future flexibility, an over-optimistic self-assessment of personal or wider economic circumstances, or advice received. It will be interesting to see what eventually tips consumer behaviour in another direction.
If interest rates are cut further, perhaps more people will take longer fixes. On the other hand, it is clear from previous experience – and FCA research on consumer perceptions of the future – that people can be sensitive to even the smallest differentials in ‘here and now’ pricing, as well as optimistic about their future circumstances.
So the extent to which people may take a rational approach to lock into ‘low for longer’ rates may not be a given.Either way, clear record-keeping by advisers will, as ever, be important, to ensure that the rationale for the customer’s product choice is kept as evidence.