Anthony Browne is MP for South Cambridgeshire, the Chair of the Conservative backbench Treasury Committee and a member of the Treasury Select Committee.
Across the UK, homeowners are opening their latest mortgage statements with trepidation, as they struggle with the rising monthly fees. The same is not true in the rest of Europe and the US, where borrowers are enjoying largely unchanged monthly payments, despite their central bank rates also rising fast.
Homeowners in the UK are uniquely vulnerable to rising interest rates because of a structural weakness of our mortgage market: our addiction to short term mortgages, with at best two or five year fixed rates. We are an extraordinary outlier: only two per cent of mortgages in the UK are fixed for more than five years, compared to over 70 per cent in Germany, 75 per cent in Netherlands, and over 90 per cent in Belgium and the US. In most of the rest of the developed world, mortgages normally have fixed rates for 10 years or more, up to the entire term of the mortgage.
Our dependence on short-term mortgages means that homeowners take on all the interest rate risk, rather than their lenders. As rates rise, British homeowners suffer, but the profits of the lenders increase. In other countries, it is lenders who take on the interest rate risk, but they are better placed than homeowners to manage it. The borrowers have far more certainty that they will be able to afford their monthly payments in the decades ahead. The volatility of our mortgage market makes our housing market more prone to boom and bust.
British homebuyers are taking out long-term loans to finance a long-term asset (their home) on short term rates, which is why lenders “stress test” the loans to see if borrows will be able to carry on paying them. This reduces access for first time buyers who need high Loan to Value mortgages of up to 95 per cent of the cost of the property. The Centre for Policy Studies estimates that if renters had access to long term fixed rate mortgages, then an additional 1.9 million renters would be able to get on the property ladder. A shift in the market would help to expand homeownership.
The UK’s whole mortgage market is structured around short-term loans. Lenders generally fund mortgages from short-term deposits, and so seek to keep the mortgages short-term. We have a whole industry of brokers, surveyors, price comparison websites and conveyancers who all make their profits by churning the market, while the borrowers face the cost and hassle of having to renew their mortgages every few years. The structure of the mortgage market makes it easier for the six major lenders to use cross-subsidies to deter competition, and ensure mortgage lending remains highly profitable.
But it needn’t be like this. Last week, I organised and chaired a roundtable with the City minister, Andrew Griffith, and the Bank of England with a wide range of stakeholders committed to opening up the British market in long-term fixed rate mortgages. Some, like Kensington, already offer fixed rates for the term of the mortgage, while others are launching them. It is not party political: both the Centre for Policy Studies and the Tony Blair Institute support a shift to longer term mortgages.
Experience from other countries such as Denmark and Netherlands show that many of the arguments against long-term fixed rate mortgages don’t stack up. Early redemption penalties can be abolished or massively reduced by making the mortgages portable (so people can take them with them when they move home) or by the borrowers hedging against the risk.
Long-term fixed rate mortgages are not banned in the UK, but the regulatory regime is stacked against them, limiting the expansion of the market. As my roundtable showed, there are many light touch regulatory changes that could level the playing field, giving borrowers a more open choice between short term fixed mortgages and long term ones. And the changes needn’t cost the taxpayer a penny.
Long-term fixed rate mortgages are less risky than short term ones, but are currently treated by regulators as the same. One simple reform is for the Bank of England to relax the loan-to-income limit on long-term fixed mortgages, such as those over 10 years, and to abolish it totally for mortgages that have fixed rates for the duration of the mortgage. The current limit of lending a maximum of 4.5 times the borrower’s income is aimed at ensuring that borrowers won’t default if rates rise. Likewise, the Financial Conduct Authority could require less stringent affordability tests on borrowers if they are taking out long term fixed mortgages, because they are less exposed to rate rises.
Pensions and insurers – which seek low–risk, long–term steady returns – are ideal funders for long term fixed rate mortgages – but the current regime means they have high capital requirements making it expensive for them. A Brexit-enabled tweak to the Solvency II regulatory requirements would allow mortgage backed securities to be less capital intensive, making them more attractive to pension funds. It is a huge failing in our finance system that we have vast funds looking for long term stable returns, and vast demand from homeowners looking for long term steady finance, but the supply doesn’t match the demand.
One suggestion at the roundtable was to stop the major lenders using cross-subsidies to keep out long-term fixed rate lenders by capping the standard variable rate (SVR) which they apply when the fixed term has ended. At present, lenders can charge any SVR they on their semi-captive customers. One option is to require mortgage contracts to include an agreed limit to how much the lender can increase the SVR above Bank of England base rate (for example, that the SVR cannot exceed base rate by more than two per cent). That would also give more protection to borrowers with short term fixed mortgages.
Price comparison websites also have a lot to answer for: they only highlight part of the cost of a mortgage, and they are structured to give huge prominence to products that offer an up front low rate, even if they are more expensive in the long run. Lenders are now required to quote an “Annual Percentage Rate of Charge” (APRC), which represents all costs and fees if you hold the mortgage to term. It is a better measure than the upfront headline rate (because it includes other charges such as arrangement fees and broker fees). But price comparison tables don’t use APRCs to rank the best buys, so the most expensive mortgages overall can still be at the top of the best buy chart. There is a strong argument for mortgage best buy tables to be required to rank them by the APRC rather than the upfront headline rate.
The Government is sympathetic to the case for opening up the market in long-term fixed rate mortgages. With relatively minor changes, homebuyers can be given a more balanced choice between short-term and fixed term mortgages, so they can choose what is right for their circumstances. Stretched homeowners, first time buyers and pension funds could all benefit. Governments in the past have considered it, but the severe impact of rising interest rates on homeowners means that politically there is no better time to make the change than now.