Lenders profit from credit crunch

Profit sign

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.

Date Base
fixed mortgage*
Margin over
base rate
Instant access
savings account**
July 2007 5.75% 6.07% 0.32% 2.52%
July 2008 5% 6.35% 1.35% 2.24%
July 2009 0.5% 4.46% 3.39% 0.15%

* Monthly interest rate of the average two-year fixed-rate mortgage up to 75% LTV
** Monthly interest rate of the average instant access deposits
Source: Bank of England

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.”