Are mortgages about to get cheaper?

22 April 2008

The Bank of England has confirmed plans to pump £50 billion into the banking system by allowing lenders to swap their mortgage-assets for government bonds. At the same time, the chancellor Alistair Darling is scheduling meetings with mortgage lenders to discuss what they can do to help borrowers struggling with rising mortgage costs.

It is likely that his message will be: 'The government has done its bit, now it’s your turn'. But to what extent the banks take up his call to action remains to be seen.

On one hand it does seem as though banks should be making efforts to reduce the cost of mortgages. We all know about the millions of borrowers facing payment shock because their fixed rate periods have ended. And then there are thousands of people with no-deposit mortgages who run the risk of falling into negative equity.

So why aren’t banks doing more?

Tightening their belts

The problem facing lenders is that the rate at which they borrow money – known as libor – has for some time been significantly higher than the Bank of England base rate. Interest rate cuts have so far failed to bring down the rate of libor – which means banks who price their products on the back of the base rate stand the risk of lending to borrowers at a loss.

The other issue is appetite for business. At the moment, there is no end of the credit crunch in sight and until the economic climate looks more positive, banks are not willing to do masses of lending. For one, they are unable to borrow sufficient funds to enable this. But in addition, the emphasis is very much on quality customers as opposed to quantity.

Despite this, all the big lenders passed on April’s 0.25% cut in interest rates in full to their standard variable rate customers. Among those players that didn’t, were Northern Rock (who cut rates by 0.1%), Derbyshire (0.16%) and Cheshire (0.2%).

The problem is not so much existing mortgage borrowers, but those looking to remortgage or buy for the first time.

So will the move by the Bank of England see lenders reduce rates for new borrowers?

The aim of the Bank of England’s cash injection is allow banks to swap “high-quality” assets, such as mortgage debt, for Treasury bills for up to three years. It is hoped that once these assets have been moved off their balance sheets, banks will see their financial positions strengthened, enabling them to increase their lending to consumers and other financial firms.

The names of those taking advantage of the scheme will be kept under wraps until the end of the six-month period in order to avoid any bank runs. Particiapants will also have to pay a fee to the Bank of England based on the current rate of libor.

Cheaper mortgage

But experts say new borrowers and remortgage customers should not expect to see mortgage rates reduce as a result of the injection.

Michael Coogan, director general of the Council of Mortgage Lenders, says: "The improved liquidity is unlikely to reverse the trend to higher mortgage costs we have seen in recent weeks.”

And Richard Farr, director of trade body the Association of Mortgage Intermediaries, which represents mortgage brokers, warns that if larger lenders “hoard” the liquidity offered by the central bank then borrowers will not benefit.

Following the Bank of England unveiling the details of its plans, Abbey announced that it would cut its tracker rate mortgages by 0.1%.

A spokesman for Abbey says: "We believe that this extra funding will, in time, reduce libor and in anticipation of this we have decided to reduce rates on tracker and flexible deals by 0.1%.”

However, the bank is not reducing the rates on its fixed rate products.

David Hollingworth, a mortgage specialist at London & Country, says Abbey’s decision will not necessarily be echoed by other players.

He adds: “Borrowers shouldn’t expect to see mortgage rates falling back down to bargain basement levels, or indeed fall at all. Instead, this injection will bring some stability back to the market and lenders will hopefully stop putting up rates as rapidly as they have over the past weeks.

“Lenders are still not in a position to start knocking down rates – but if the injection does see a return to normality, then hopefully in time we will see the cost of new mortgages fall slightly.”

Should the government do more to reduce mortgage rates or is it the turn of the banks?

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