The rollercoaster of UK mortgage rates is the price to be paid for low-cost, brief-term arrangements.
After the 2008 banking crisis, borrowers who chose a short-term loan were fortunate; current borrowers have had similarly bad luck.
Some borrowers are pondering whether there is anything to be said for the certainty of setting the borrowing rate for the whole length of the loan as mortgage lending rates soar to levels unseen since the banking crisis.
Two of the largest lenders in the UK introduced 25-year fixed-rate mortgages in 2007. They were reacting to a demand from Alistair Darling, the former chancellor, who indicated that customers would be better off if they were not required to shop for a new package every two years, usually incurring fees each time.
The interest rates at the time were not very high: Halifax and Nationwide both charged 6.39% on their packages, the Bank of England base rate was 5%, and the typical two-year fixed-rate was 6.24%, per data from Moneyfacts. Nevertheless, neither lender’s branches experienced a stampede. The sole information provided by Nationwide was that “historically, take-up of 25-year fixed mortgages has been low, with borrowers preferring the flexibility of shorter-term deals of two- to five-years.”
Those who selected a temporary solution will have felt vindicated in the years that have passed. The Bank of England started lowering interest rates in reaction to the 2008 banking crisis. Borrowers with variable-rate mortgages benefited right away, but those leaving fixed-rate mortgages were able to secure ever-cheaper arrangements when low rates became the norm.
A borrower who chose to ride the rate rollercoaster would have achieved enormous savings by 2020, when the most affordable two-year fixed rates were under 1%, only partially offset by any fees they may have paid along the way. For a mortgage of £150,000, for instance, the monthly payments would have been £1,003 at a rate of 6.39%, but £554 at the 0.83% Halifax was offering two years ago. (Over 25 years, a borrower paying the higher rate would have paid £300,757; a borrower paying the 0.83% rate would have paid £166,152.)
It appears improbable that many, if any, borrowers anticipated the impending financial crisis and decided accordingly. Instead, they made a short-term decision and were fortunate with their timing at a time when home values were rising.
The current group of debtors with short-term contracts has also had bad luck.
The benefits of long-term fixed rates were discussed by Prof. David Miles when the Labour administration asked him to look into how the UK could create a mortgage market in 2003. Nearly 20 years later, his comments still ring true.
One of his findings was that “many more mortgages would be at rates that were fixed for durations longer than is currently customary if the market operated better. When the stock of their debt was high relative to their earnings and the impact of interest rate charges on the affordability of their mortgages was significant, more borrowers would then be protected from the effects of unexpected increases in interest rates.
He now claims that the mentality in the UK appears to discourage people from paying any more than is necessary in the short run. “I think there has been a mindset in the UK that getting on the housing ladder is what matters and that tomorrow will (probably) be OK once you do that,” the man added. Borrowers are prone to choose the cheapest agreement, whether it is a fixed-rate or variable arrangement, in order to make that happen in a nation where prices are high compared to income. This is true even though fixing for five years or longer results in fewer stress tests and may enable you to take out larger loans.
According to Miles, long-term fixed rates in the UK have a history of including penalties, leaving you trapped with a high rate if base rates decline. In the US, they allow people to refinance to a lower rate to combat this, but everyone pays the price because rates are higher than they would otherwise be.
“If you offered that re-financing option on long-term fixes in the UK, then it would mean that the fixed rate was more frequently above the variable rate – and people frequently just choose the lowest repayment at the beginning of the mortgage.”
One industry source asserts that brokers play a part in keeping the market short-termist since they are paid when a new agreement is taken out and have no motivation to commit their clients for the long term. This is in addition to borrowers’ desire for the best bargain available.
Concern over maintaining options appears to be another reason. Although many mortgage lenders now permit clients to “port” their loans if they move homes and overpayments, buyers still believe that short-term financing offers more flexibility.
People may have been discouraged from paying more for a longer-term arrangement because they anticipated that prices would continue to climb and rates would continue to drop, according to Neal Hudson, a UK housing market expert at the consultancy BuiltPlace. “The overall experience over the past 40 years has been that people have always turned out okay. There may have been some short-term pain,” he said.
“Now that the market has obviously bottomed out, will anything change? A long-term solution might start to seem more tempting.
However, no one appears to be advocating a sudden rush for the only 25-year offer on the market right now, Kensington’s mortgage loan with an interest rate starting at 5.57%. Our connection with rates appears to be steadfastly short-term, despite the constant discussion of everlasting houses on television and the increasing lengthening of our mortgage terms to three or even four decades.