Lenders and borrowers are both paying a high price for bailing out failed banks

I was incensed to read some of the comments made on Mortgage Strategy Online about Moneysupermarket’s research last week suggesting that the majority of borrowers would be better off remortgaging than staying on their lender’s SVR.

Once again brokers display their ignorance of the way mortgage funding works. I see this so often that I’m amazed some of these guys ever passed CeMAP.

In response to comments that lenders should be charging lower SVRs because the Bank of England base rate is 0.5%, remember the base rate has nothing to do with mortgage rates and never really has.

The mortgage rate charged is based on the cost of the funds being lent. At the moment the only way most lenders can get funds is from investors who won’t accept the base rate for their money when state-backed lenders are offering up to 4%.

Then there’s the issue of increased liquidity required by the Financial Services Authority. This has to be invested by lenders unprofitably because that’s what they have been told to do.

The remaining lenders are paying for the follies of the failed banks through the Financial Services Compensation Scheme.

If you are a saver your returns are pitiful whereas if you are a new borrower with less than 20% deposit or equity your interest rate will be punitive

Let me break this down into simple terms. The mutual I work for borrows money at about 3% and has to invest 30% of this in government gilts which pay less than 0.5%. Then we have to cover our overheads of about 1%.

As a building society our profits are the main thing we have to add to capital reserves.

I wonder if you’d be happy to lend your own money at 2% above the base rate if it had cost you more than 4% to obtain it?

The crux of the matter is the differentials that lenders are working on at the moment. If you look at lenders’ margins in the past 30 years or so you’ll find they average between 0.75% and 1.5% rather than 4%.

You’ll also find that, taken as an average, the current returns on most existing investment accounts struggle to exceed 1%.

So in a way there is a link between the base rate, LIBOR and mortgage rates – the base rate and LIBOR at 0.63% are being used to set the criteria for investments while SVRs hover between 3.75% to 5.5%.

The link is that if you are a saver your returns are pitiful whereas if you are a new borrower with less than 20% deposit or equity your rate is punitive.
It will be interesting to see if lenders abandon these differentials when interest rates start to climb – I think doubt it. Talk about paying twice for the banks’ rescue.