Lenders profit from credit crunch
Banks and building societies have seen margins on mortgages soar over the past two years despite the official rate of interest falling from 5.75% to just 0.5%.
Data from the Bank of England shows that the average rate of a two-year fixed mortgage has decreased from 6.07% in July 2007 to 4.46% in July this year. However, the margin on this type of loan over base rate has increased from 0.32% to 3.39% today.
Mortgages are not the only type of loan where the margin over base rate has risen. Overdraft rates have increased from an average of 17.73% in July 2007 to 18.97% in the same month this year. The margin on this type of lending, meanwhile, has soared from 11.98% two years ago to 18.47%.
And credit card rates have increased from an average of 15.22% (giving a margin over the Bank of England base rate of 9.47%) to 15.87% - a shocking 15.37% margin over base.
Meanwhile, savings rates have taken a battering from the historically-low base rate. The average instant access account paid just 0.15% in July this year, down from 2.52% in 2007.
* Monthly interest rate of the average two-year fixed-rate mortgage up to 75% LTV
The base rate, which is set by the Bank of England’s Monetary Policy Committee each month, has fallen from 5.75% in July 2007 to just 0.5% today. The central bank says this monetary policy is designed to control inflation and help struggling borrowers and businesses weather the recession.
With house prices crumbling and confidence in property hitting a wall, the move also aims to underpin the housing market.
However, taking the average loan rates at face value, it looks as though banks and building societies are raking in the profits from loans such as mortgages, despite the record-low base rate.
So, is this a sign that banks and building societies are taking advantage of the credit crunch and charging consumers more during a time when money is tight? Or is this just a sign of the times?
Brian Mairs, spokesman for the British Bankers’ Association, says the perception that base rate forms the basis for lending is inaccurate. “No one is going to be able to borrow money at 0.5%,” he adds.
David Hollingworth, a mortgage expert at London & Country, agrees, and points out that there is not a direct correlation between the base rate and mortgage rates. This is because mortgage lenders mainly use swap rates – the cost of funding from the wholesale markets – to price their fixed-rate loans.
According to Ray Boulger, senior technical manager at John Charcol, the key factor influencing swap rates is what the money markets think the Bank of England base rate will do in the short to medium term. Over the past few months, swap rates for two-year loans have fluctuated between 1.9% and 2.3%, an indication that the markets believe the base rate will rise over that time.
Although the cost of wholesale mortgage funding is higher than the base rate, Hollingworth still believes that many lenders have increased their margins over the past two years, with most looking to take a bigger profit from the loans they issue.
“In 2007, there was no margin in lending, and the sheer amount of competition meant there wasn’t a lot of money to be made from mortgages,” he explains. “With wholesale funding for mortgages drying up over the past few years, it’s natural that banks are seeking more profit from the loans they do issue. This isn’t about greed – it’s more about the fact that demand for mortgages continues to outstrip supply.”
In addition, the recession means banks have to be more careful with the money they have. “The state of the economy means money is scarce, and the money that is available is expensive,” says Mairs. “For banks, there is also a higher risk that borrowers will default on loans during a recession, therefore they need to price their loans to reflect these factors.”
It also comes down to banks and building societies wanting to limit the amount of business they receive from borrowers. Lenders that price their mortgages too competitively in the current market, risk receiving a surge of interest that they simply can’t cope with, says Boulger.
The problem with comparing the market today with the market two years ago is that neither situation is right. “We shouldn’t see 2007 as a yardstick for a ‘normal’ mortgage market,” says Mairs. “The years before the credit crunch hit were an era of cheap credit, and this was not sustainable.”
Hollingworth agrees that there is little point in looking backwards: “We certainly shouldn’t expect things to go back to the way they were pre-credit crunch.”
An overdraft is an agreement with your bank that authorises you to withdraw more funds from your account than you have deposited in it. Many banks charge for this privilege either as a fixed fee or charge interest on the money overdrawn at a special high rate. Some banks charge a fee and interest. And other banks offer a free overdraft but impose very high charges for exceeding the agreed limit of your overdraft.
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).