By Andrew Mullineux, Emeritus Professor of Financial Economics, Centre for Responsible Business and CHASM
Until this week’s ‘price war’ among the major lenders, UK mortgage rates had been at their highest since the financial crisis in 2008, causing sleepless nights for those needing to remortgage after enjoying much lower two, or five-year fixed terms. And with inflation still high and more interest rate rises from the Bank of England still likely to try to lower it, mortgage rates could go up again in the near future.
All of which has increased calls for longer-term fixes, such as the 10 to 15-year fixes widely available in Germany, France, the Netherlands and Switzerland; or the 30-year fixes that have become standard in the US. But the willingness to fix, even for two years at today’s higher rates, has abated as borrowers wait for rates to continue falling. In the meantime, many households may opt for (interest rate) ‘tracker’ mortgages.
With inflation still high and more interest rate rises from the Bank of England still likely to try to lower it, mortgage rates could go up again in the near future.
This highlights the interest rate risk faced by banks and other originators of fixed-rate mortgages funded by shorter-term savings deposits. Their revenue from home loans is fixed but the cost of periodically refinancing the loans with deposits rises, as they eventually pass interest rate rises on to savers – at least in part. Further, once inflation is under control and interest rates are reduced again, borrowers have an incentive to refinance their mortgages at lower rates if early repayment fees are not prohibitive, squeezing lenders’ profits again. Indeed, US borrowers would be unwilling to seek 30-year fixes if refinancing fees were too high.
The attraction of longer-term fixes for lenders is that they encourage borrowers to pay more interest in aggregate than shorter-term mortgages, under which the principal sum borrowed is paid off more quickly. But in the US (and Switzerland) interest paid on mortgages is tax deductible, unlike the UK where mortgage interest tax relief was fully removed in 2000. So, deductibility may be an important factor in making borrowers more willing to pay more aggregate interest on their home loans.
To attenuate interest rate risks, lenders could issue bonds with terms more closely matching their fixed-term mortgages, which is essentially what is done in Germany (on the ‘Pfandbrief’ market) and Switzerland, where highly regulated central mortgage bond issuers serve the two main banking groups. In the US, the 30-year fixed-rate mortgages qualify for securitisation in a market organised by Government Sponsored Agencies (GSAs) that are implicitly government-backed. They underpin the resulting Mortgage-Backed Securities (MBSs), which allow the approved originators to pass on the interest rate and prepayment risks to investors buying the bonds. In addition, the Federal Housing Association (FHA) guarantees home loans to low- and moderate-income borrowers, who must pay a mortgage insurance premium to qualify.
In the US and elsewhere, including the UK, securitisation of non-standardised mortgages ballooned in the run up to the 2007-8 financial crisis, which was largely caused by the mis-selling of mortgages and the mispricing of their associated risks. Non-standard home loan securitisation has revived under stricter regulation in recent years, particularly in the US, allowing originators to better manage the risks associated with their mortgage assets and to refinance their own positions.
If the UK wants to encourage a supply of similar longer-term fixed-rate mortgages, then tightly regulated mortgage bond markets and affordable repayment fee structures will be required to underpin it. For affordable, very long-term fixed-rate mortgages to become widely available, as in the US, government-backed mortgage and standardised MBS guarantee systems are also required. The FHA was established in 1934 and the Federal National Mortgage Association (‘Fannie Mae’) in 1938, the first of the mortgage GSAs, as part of a US policy to promote home ownership. Other countries – like the UK, so far – have been more willing to allow the home rental and ownership markets to develop without this kind of intervention.
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The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of the University of Birmingham.