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The 25-year trap

The government wants clients to take out long-term deals but a one-size-fits-all approach won’t work and many consumers aren’t interested in long and binding contracts, says Mark Skinsley

Last month chancellor Alistair Darling delivered his Budget speech during testing times for the housing market and he took the opportunity to champion the case for long-term fixed rate mortgages.

Darling said long-term deals “protect borrowers from risks and still allow them flexibility to move or get a new mortgage if rates go down”.

He pledged to set up a working party to look at how lenders can make such products more attractive to borrowers. But the big question is whether this is desirable or even workable.

“The fundamental role of brokers is to match customers’ circumstances to products that are suitable for them,” says Phil Rickards, head of sales at BM Solutions.

“It may be that long-term fixed rates are the right choice for some borrowers but they won’t suit everyone.”

The main argument in favour of Darling’s proposals is that long-term products protect borrowers from rising interest rates, giving them peace of mind that repayments will remain constant and in theory affordable over long periods of time. They should also provide more stability for the mortgage market.

At the moment just a handful of lenders offer 25-year fixed rates and only Manchester gives borrowers the option of 30-year deals.

The inevitable drawback with long-term mortgages is the pressure they put on borrowers. Being tied down for 25 years can be a daunting prospect, especially since borrowers’ financial situations are likely to change during that time.

“Clients’ circumstances can change a lot over 25 years,” says Rickards. “One product is unlikely to be the right choice for the whole period.”

But increases to the Bank of England’s base rate will worry many borrowers on short-term deals.

Right now interest rates are reasonably low but the base rate was almost 15% in October 1989.

Taking out long-term fixed rate deals can be a smart move or a dangerous one depending on future interest rates.

Long-term deals have a role to play in protecting some borrowers.

“They shield certain clients, for example, older borrowers coming towards the end of their mortgages or those who have lost their jobs,” says Roger Morris, managing director of em-financial.

With the base rate dropping as low as 3.5% in July 2003, that would have been a good time for borrowers to make longer mortgage commitments.

Another positive aspect of long-term fixed rates is that they avoid the costs associated with regular remortgaging. If borrowers take out regular short-term products the costs soon mount up.

“This is the case because fees have increased dramatically,” says Richard Barker, product manager for mortgages at Norwich and Peterborough.

While this is true, the costs of withdrawing from long-term fixed rate products can also be high, leaving borr- owers trapped.

It is this inflexibility and the inability to change lenders that makes clients wary of such deals.

Some lenders offer 10-year opt-out clauses in their 25-year packages. While this gives borrowers the opportunity to reassess their situations, 10 years is still a significant period of time.

“There has been a reasonable amount of innovation in the past few years as we have seen larger lenders enter the long-term market,” says Barker. “Abbey, Halifax and Nationwide offer 10-year deals and longer.

“Lenders will try and differentiate products more and deals are becoming more competitive. Two to three years ago 10-year deals were fairly straightforward. Recently categories have become more varied.”

While there has been an increase in the number of lenders offering long-term fixed rates in the past couple of years, the question of whether consumers want them still remains.

The chancellor’s stance seems at odds with brokers’ daily experience of clients’ desires.

“Darling is being naive,” says Morris. “Brokers can see which clients will benefit from such deals.”

This seems to be the main issue – not all customers suit long-term deals.

“Modern life means long-term deals are not right for everyone,” says Danny Lovey, proprietor of The Mortgage Practitioner. “I operate in the real world. I’m not looking to give clients 25-year liabilities.”

There seems to be a conflict of interest here too. The government backs long-term deals to promote economic stability but home owners want the freedom to reassess their housing situations every couple of years.

“I think the chancellor wants long-term fixed rate mortgages not for the benefit of consumers but for the government,” says Morris.

“It would improve the stability of house prices but it’s not in the interest of borrowers.”

A move towards long-term deals would represent a substantial shift in the mortgage market’s mindset too.

“If Darling can get the industry to champion long-term products it would modify consumers’ passion to constantly source rates that are better for them,” says Morris.

Not only would this stop home owners sourcing more competitive deals, it would also restrict their ability to buy new properties.

“For Mr and Mrs Average who are both working and want to scale the property ladder, it’s not the right choice,” he says.

Lovey doubts whether long-term mortgages are suitable for first-time buyers either.

“Recommendations need to suit clients’ needs,” he says. “The chances of recommending long-term mortgages to first-time buyers would be rather small as they probably wouldn’t suit their circumstances.”

Morris also questions the compatibility of long-term deals with the domestic market.

“Darling is taking a European attitude to the issue,” he says. “In Europe, you buy a house and you never sell it as your parents may live with you.

“But it’s our constant demand for change that drives the economy. If we took on a European approach our ability to grow would diminish.”

It is these differences in lifestyle that make long-term fixed rates more appealing on the Continent than here. It is also a reflection of how the UK has changed over the years.

“Thirty years ago long-term fixed rate mortgages would have been more attractive because life was more stable and divorce rates were lower,” says Lovey.

“Nowadays life can be volatile and 25-year products might be too inflexible. Two, three or five-year fixed rates could prove to be more appropriate and deals borrowers are more comfortable with.”

Looking further afield, long-term deals have proved popular in Australia, largely as a result of profitable commission rates for brokers.

“In Australia, the take-up of long-term fixed rate deals is higher,” says Morris.

“Brokers tend to push the products as they receive trail commission, getting a percentage of the mortgages each year.”

Such a long-term investment culture does not exist in the UK. This, combined with borrowers’ hesitancy to take out longer deals, makes it unsurprising that the long-term market remains underdeveloped.

Is there another way to provide borrowers with flexibility while also providing them with protection from fluc- tuating interest rates?

Yes, but at a cost. To provide borrowers with opt-outs, lenders must increase their premiums.

“We launched a 25-year mortgage deal last year that ties customers in for the first decade,” says Barker. “Then they can redeem penalty-free but at a price.

“Clients can go for low rates with restrictions or higher rates with more freedom. It depends on what people are willing to pay.” One option available to lenders is offering five-year fixed rate mortgages. While five years is still too long for some, it does represent a compromise for borrowers unsure about taking on longer commitments.

A stable economy could be one way of stemming churn in the short-term mortgage market.

“The chancellor and the Prime Minister should produce a long-term stable economy with less fluctuation in interest rates,” says Morris.

More stable rates would discourage borrowers from constantly searching for better deals.

There is also an argument for making longer deals more flexible. One way would be to reduce the early repayment charges involved.

But while this would be attractive to borrowers it wouldn’t provide lenders with the protection they want.

“I don’t see long-term fixed rates becoming popular until someone comes up with a better structure that makes sense for both parties,” says Lovey.

So it remains difficult to strike the right balance between protecting lenders and borrowers.

Ultimately there is an element of risk for both sides in long-term mortgage arrangements.

Given that borrowers’ circumstances can change quickly, building underpayment and overpayment options into policies can help mitigate against potential changes in relationships or employment status.

“The ability to overpay and take payment holidays would help,” says Morris.

While there is obvious competition from short-term fixed rate mortgages, their dominant position in the market may not be the cause of long-term deals’ unpopularity.

“More attractive short-term rates aren’t responsible for the unpopularity of long-term deals,” says Rickards. “It’s unrealistic to suggest that one product type is right for everyone.”

What is clear is that regardless of the government’s push for more long-term deals the needs of customers must remain paramount.

“It’s not a case of making long-term deals more popular,” says Rickards. “Brokers should not suggest these products for any reason other than they’re the most suitable ones for individual borrowers.”

In the short term it is hard to tell whether longer term deals will grow in popularity.

“They could become slightly more popular but a lot will depend on interest rates in the next 12 months,” says Barker.

“Hopefully the government will provide some incentives. It’s in its interest to have a stable mortgage market.”

Long-term rates no panacea for market ills

Andrew Montlake is partner at Cobalt Capital

Expectations have been heaped on long-term fixed rates by a government looking for an easy way out of the problems facing the market. And if you believe chancellor Alistair Darling, commission-hungry brokers are only selling short-term mortgages to get their greasy mitts on remortgage proc fees.

But this is wrong. The majority of brokers are honest and many hate to be referred to as salespeople. They are professional advisers and their job is to guide borrowers through the mortgage maze and ensure they get products that suit their needs and financial circumstances.

Brokers react to client demands and clients react to the society they live in. In our fast-paced world things change quickly. Consumers move jobs and get divorced, singletons move into relationships and a growing number of people emigrate. In other words, clients have to be flexible to cope with a constantly changing environment.

Price is also a factor. Borrowers are attracted to the cheapest options on offer and traditionally shorter term rates are cheaper than longer term deals.

So when clients first meet brokers they want the best rates on offer and tend not to have thought about their future requirements – their overriding priority is cost.

But once brokers have gone through the ‘know your client’ exercises and borrowers understand their options, they are more likely to take medium to long-term fixed rates.The government needs to understand what brokers do and get to grips with clients’ desires.

The government likes to point the finger at lenders that in its view do not offer a choice of long-term rates. It also thinks that the deals on offer are not priced competitively.

But a quick look at Mortgage Brain reveals there are at least 18 lenders that offer rates for 10 years or more and a total of 70 different long-term products. Some are flexible, some are not and deals come in variable, offset and fixed varieties. In other words, lenders are already offering consumers choice.

The only reason more long-term products aren’t available is demand. Lenders would prefer to keep borrowers for longer so if demand for such products was higher there would be more of them.

As for pricing, we are aware of the liquidity crisis lenders face right now. Why would they offer products that lose them money in the long run? They are not charitable organisations but mature businesses run on tight models.

Woolwich managed to come up with a fantastic 10-year fixed rate at 5.29% a couple of weeks ago and should be applauded. But if it’s that easy to offer market-leading products, I expect the government’s own lender Northern Rock will rocket to the top of the long-term best buy tables sooner rather than later.

Many lenders are being forced to cut the rates on their longer term deals due to their need to decrease consumer demand for short-term products, so the government may see its wish partly fulfilled.

But the reality is that the public wants choice. Consumers want the option of long or short-term rates, of flexibility or stability, and all at the lowest cost possible.

Getting all borrowers to take on long-term deals is not the panacea for the mortgage market that Darling thinks it is and consumers won’t play ball anyway.

What matters most is offering clients choice

Andy McQueen is managing director of UCB Home Loans and The Mortgage Works

The government is trying to mould the UK mortgage market in the image of the US one but there are meaningful differences between the two.

Across the Atlantic it’s commonplace for public companies like Fannie Mae and Freddie Mac to buy large numbers of mortgages from lenders, meaning they take responsibility for interest rate changes and resultant swap breakage costs. We don’t have a system like that here and no-one is suggesting we should launch one.

The government’s focus on longer term mortgages is part of a drive that dates back to Professor David Miles’ report on the subject published in 2004. The report said long-term fixed rates were a good thing but only picked out their best points. I think the obsession with such deals is misplaced.

Nobody can deny that long-term products have a place in the market providing they are portable and offer borrowers the chance to move but they are not appropriate for everybody. Buyers looking for their first or next mortgage who believe we are at the top of the interest rate cycle are unlikely to opt for them. They need more options.

Many borrowers find it difficult to predict how their personal circumstances will change over the next 10, 15 or 25 years. Shorter term deals give them the flexibility to manage changes in their personal lives.

The market offers borrowers a wide range of products and has launched 25-year fixed rate products for clients who don’t want to remortgage. And in the buy-to-let sector, long-term deals have been well received by brokers and landlords. They are not suitable for everybody but mortgages that don’t require constant revisiting and remortgaging can be ideal for professional landlords.

While some commentators have suggested that longer term fixed rate products will be poorly received by brokers reliant on the regular income that remortgaging brings, we maintain brokers are driven first and foremost by the desire to do right by their clients.

And some lenders understand that long-term deals involve less remortgaging and fewer proc fee payments so the remuneration they offer brokers is adjusted to reflect this.

Long-term fixed rate mortgages are not suitable for everyone but they offer an important choice for borrowers prepared to set their interest rates for longer periods in return for more security.

Nevertheless, they should be only one of a range of products that brokers can access depending on customers’ needs, financial sophistication and attitudes to risk.

Darling should think less about long-term deals and more about liquidity

Nicola Severn is head of public relations at edeus

Several weeks ago financial services website Fairinvestment.co.uk claimed that 37% of borrowers would opt for 25-year fixed rate mortgages if they had the option to do so.

James Caldwell, director of the website, argues that home owners who are approaching the end of their fixed or discounted periods are facing increased mortgage costs and would benefit from the security long-term fixed rates bring.

Besides the fact that the sample used in the survey was small, the findings – accompanied by a quote from Alistair Darling – once again brought into focus the chancellor’s fixation with long-term fixed rates.

As is well known, the increased provision of these products has been touted by the government as a key solution to the market’s ills. But many argue that Darling’s priorities are misplaced and he is putting too much emphasis on long-term mortgages when other matters are more pressing.

While many home owners may be attracted by the security of long-term fixed rates, they are not a blanket solution to the problems borrowers face.

Although it’s true that long-term deals may appeal to some, the fact that few borrowers opted for them before the credit crunch took hold indicates that their appetite for the long game is not as voracious as Darling and his associates think.

Although long-term fixed rates have a place in the market, their appeal is limited. For individuals who take a cautious approach and are keen to ensure their monthly mortgage payments remain the same each year, they are attractive.

But as we have seen, many borrowers prefer flexibility and the option to review their mortgage arrangements on a regular basis to secure products that are most suitable for their circumstances.

The idea of encouraging payment stability is a positive one and has its origins in ensuring borrowers are well placed to service their mortgage debt to avoid getting into financial difficulty. But rather than an exclusive focus on long-term products, clients would benefit from a variety of options. For some, medium-term fixed rates or switching facilities may be more appropriate.

There is no doubt that the mortgage market could benefit from a more mindful approach that considers how product development can be more closely aligned with borrowers’ requirements. Indeed, before the liquidity crisis took hold, many lenders were developing innovative products and considering the possibilities of bespoke loans.

But priorities have changed. Now the focus is on adapting to the new environment and riding out the global economic storm. The chancellor’s obsession with long-term fixed rates is not the solution and he’s trying to shut the stable door after the horse has bolted.

Before trying to increase payment stability Darling needs to find a way of restoring liquidity to the market. Until this happens and funds become more readily available, borrowers may think themselves lucky if they manage to secure mortgages at all.


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