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Cover story: Is locking in for longer the future for fixes?

Ten-year fixes are gaining popularity amid Brexit uncertainty. But experts think the shape of the market is unlikely to change significantly without greater competition and innovation, plus help from the regulator

Mortgage brokers are reporting more client interest in fixed-rate deals beyond five years as rates on 10-year fixes fall below 2.5 per cent.

With the Bank of England base rate at 0.25 per cent, many borrowers have been looking to stay on variable rates to take advantage of the historic lows. This has led some lenders, seeking to compete for fixed-rate business, to divert the attention of borrowers away from variable deals.

The best rates on five-year fixes have fallen below 2 per cent while the best two-year deals for vanilla borrowers with high deposits have fallen below 1 per cent.

And the market for even longer-term deals is heating up as major lenders offer mouth-watering headline rates for their preferred borrowers.

Some lenders such as Santander have even briefly offered higher proc fees for brokers who sell 10-year deals.

Moneyfacts data shows Barclays, Coventry Building Society and TSB all offering 10-year fixes below 2.5 per cent through brokers. First Direct also has a direct-only deal at 2.49 per cent.

Brokers say uncertainty over Brexit negotiations, ultra-low rates and the likely future trajectory of interest rates are encouraging borrowers to consider fixing rates for a decade.

“The potential impact of Brexit negotiations is leading more clients to consider medium- and longer-term mortgage deals,” says Lentune Mortgage Consultancy founder Stuart Gregory.

London & Country associate director of communications David Hollingworth says borrowers are seeking out deals beyond five years due to narrow spreads between five- and 10-year fixed prices.

“We have seen increases in mortgages beyond five years,” he said. “If you have a deal that narrows the margin between 10- and five-year deals, it can pique interest with borrowers.

“Many can see the benefits of locking in rates for the long term as it is unlikely today’s rates will ever look like bad value. There has been an increase in those looking longer.”

MoneyFacts finance expert Rachel Springall says its data has shown a clear uptick in demand for 10-year deals, with prices falling.

“Decade-long fixed mortgages are clearly becoming a new favourite among lenders that want to provide borrowers with a long-term option to secure monthly mortgage payments,” she says.

“This trend may continue to grow in times of uncertainty but borrowers must always work out the true cost of any deal and be sure that their circumstances will remain relatively unchanged for the next 10 years.”

Lingering reluctance

Yet some borrowers persist in opting for shorter-term fixes and variables with a higher tolerance for the risks of interest rate rises.

In addition, many 10-year deals are available only up to 60 per cent or 70 per cent LTV, with heavy early repayment charges and arrangement fees of around £999.

Springall says 10-year deals typically carry early redemption charges that run up to the final year of the initial fixed deal. Decade-long mortgages may not be appropriate for borrowers who want to move or remortgage in the next few years, she adds.

Gregory says: “Three- and five-year mortgage deals are more popular than 10 years and, for more clients to consider longer-term rates of seven and 10 years, there needs to be more competition in that area of the market with more lenders offering those rates.”

“In addition, the onerous early repayment charges on longer-term deals need attention.

“We still have an environment where, over the years, borrowers have been offered a maximum fixed-rate period of only five years. That will take some time to open up. It can, however, only be done with innovative moves from lenders.”

Hollingworth says the low price of shorter-term fixes remains attractive and some borrow-ers are reluctant to lock in to deals for five years or more.

“It still remains a small part of the market,” he says.

“Ten-year deals can look like bad value if you have to make early repayment charges, take out a top-up loan or move house. Taking one with you to a new property starts to look problematic.

“Mortgages will be portable but the terms may not be as favourable and we have seen problems with that. That is what puts people off longer deals.”

Beyond 10 years

It has been a long-held goal of some policymakers to encourage fixed mortgages beyond 10 years. In 2003, then-chancellor Gordon Brown commissioned economist David Miles to write a report on the feasibility of establishing a longer-term mortgage market.

Brown was keen to import a US-based system where most mortgages are fixed for the entire mortgage term of, typically, 30 years. Borrowers can refinance but there is no major change in monthly payments resulting from an increase in central bank rates.

The Miles Report, published in March 2004, called for a range of reforms to improve advice and transparency of pricing, remove regulatory barriers and enhance funding structures.

The report argued that long-term fixes were unpopular in the UK for three reasons: first, borrowers were not highly leveraged, so they did not find long deals compelling; second, borrowers preferred to take risks associated with variable mortgages rather than fix their rates; and third, borrowers paid more attention to initial monthly payments than to those made over decades.

At the time of the report, the Building Societies Association said the market could be trapped in a “bad equilibrium” of short-term deals, while the Council of Mortgage Lenders said the market structure made some members “uncomfortable”.

Despite the consensus on the need for action, however, the Miles Report has remained effectively dormant for the intervening 13 years.

GPS Economics director and economist Gary Styles says central government needs to steer the industry towards offering longer-term deals to ensure greater stability for both individual borrowers and the wider economy.

“The consensus among economists is that long-term fixes are particularly good for first-time buyers because they take away that risk and give certainty,” he says.

“The issue is that banks have been reluctant to market and push those as much as they probably should have for the long-term health of the housing market.

“It is a dilemma. Common sense will tell you that a long-term fix would be a good way to take away interest rate uncertainty for those who are highly leveraged, but it doesn’t seem to work out. If anything, products pushed the most are those that are cheaper today, rather than the long-term ones.”

Brokers say fixed-rate mortgages beyond 10 years could be an attractive option for borrowers but there are no such deals available due to swap rates and regulatory barriers.

Swap rates have swung significantly since last year’s Brexit vote but the rate on long-term swaps remains at historic lows. On 6 April, 10-year swap rates were 1.08 per cent compared to 1.69 per cent for 30-year deals, creating a theoretically more expensive fixed-rate mortgage over 30 years.

One cause of lenders’ reluctance to create longer-term fixes is that the market for buying longer-term swaps is less liquid. This means it is harder to buy and sell swaps, which makes pricing less certain.

To address regulatory concerns, the Miles Report called for capital adequacy rules to be relaxed for lenders that offered longer-term mortgages, to make these products more attractive.

“The longer the fixed rate, the more capital lenders need,” says John Charcol senior technical director Ray Boulger.

“It is a bizarre situation because lenders are offering a 30-year mortgage where the first two years are fixed at a discount before it moves to the reversion rate. To do this, they need less capital than when offering a 30-year fixed-rate deal.

“The logic is that those taking out a two-year fixed rate will not stay with lenders for 30 years whereas, if you take out an actual 30-year fix, the presumption is that you will stay with them.

“However, you will have a rate guaranteed whereas, if you start with a two-year fix, who knows what interest rate you may end up paying? It is a regulatory problem for lenders to offer longer rates.”

Styles says he remains hopeful that the Miles reforms could be picked up again and more action could be taken by the Treasury to boost longer deals.

“David Miles’ report gave a compelling explanation of the benefits, and it still stands,” he says.

“But, practically, if lenders are much happier with variable rates or shorter-term fixes, it is difficult to change. There are some very attractive deals and there has been a push to encourage buy-to-let landlords onto longer-term deals.”

Cultural shift

Brokers say that to create a US-style system in the UK would require a cultural shift in the selling and pricing of mortgages. In December 2012, 61 per cent of all US mortgages were taken out as 30-year fixed-rate deals.

The popularity of these products is often traced back to the Great Depression of the 1930s and fears of repossession. To boost homeownership during that period, US government housing programmes sold 30-year fixed-rate deals, which spread through the market.

These unique circumstances mean it may be unfeasible to transfer this cultural policy across the Atlantic. John Ligon, senior policy analyst and research manager at US think-tank the Heritage Foundation, criticised the narrow focus of the US system in a 2014 report on 30-year mortgages.

“Diversification across mortgage products benefits not only the overall market but also individual customers, who benefit from having more choices,” he said.

“Having many different options in available mortgage products is critical to a well-functioning market because borrowers’ needs vary and frequently change.”

However, when longer-term deals have been offered, there has been appetite for them. In 1989, Bear Stearns offered a 30-year fixed-rate deal in the UK with no early repayment charges through a limited group of brokers. The bank’s aim was to import US-style long-term fixed-rate deals to lock in borrowers over decades.

Of course, the UK mortgage market in 1989 was a very different place from today’s, with base rates at around 15 per cent and fixed rates undercutting variable deals.

“[The Bear Stearns deal] was very popular,” says Boulger, who sold the 30-year mortgage through John Charcol.

“The reason was that interest rates were sufficiently below the variable rate to make it attractive. When the bank offered it, base rates were in the high middle teens, with standard variable rates around 15 per cent.

“It is a very different situation today as the base rate is guaranteed to go up, but not in the short term and only slowly. It means the premium you pay to lock in long-term fixed rates is very low. That makes long-term rates attractive.

Role of brokers

The Miles report suggested mortgages would become cheaper by “minimising” the cost of intermediation and cutting out the broker. Yet the Heritage Foundation paper concludes that brokers serve to make the market more competitive, and therefore cheaper, by providing consumers with greater choice.

As brokers report increasing borrower interest in longer-term deals beyond five years, this could alter the shape of the mortgage market. Although the UK is unlikely to adopt a US-style system – which so attracted Gordon Brown in 2003 – economists will continue to push for mortgage structures that reduce risks to borrowers.

For now, both borrowers and brokers can benefit from a range of rock-bottom deals with 10-year terms that would have been unthinkable a decade ago.

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