Ray Boulger: Fixed rates keep getting cheaper

“Today’s no change decisions on both Bank Rate and Quantitative Easing were both wholly expected. The comment from HBOS’s former Chairman, Lord Stevenson, in a letter of 18 March 2008 to the Chairman of the FSA, published this week following his appearance at the Commission on Banking Standards, claiming just 6 months before HBOS had to be rescued was that its business was “boringly boring,” was clearly somewhat misleading, but these two words could very aptly be used to describe today’s announcement from the MPC.

“The figures released this week by the Bank of England of the amounts drawdown from the Funding for Lending Scheme (FLS) by those institutions already signed up to the scheme, and their net lending in its first two months - August and September, say very little about the effectiveness of the scheme as far as the mortgage market is concerned because:

• Net lending relates to both mortgages and non financial companies, with no breakdown between the two.

• Some banks in the scheme, particularly RBS, have been rapidly deleveraging overall, but still increasing net mortgage lending. Although RBS reported negative net lending of £642bn for the 2 months most, if not all, of this is likely to have resulted from corporate business. Last year, despite a large decrease in the size of its Balance Sheet, RBS still increased its net mortgage lending. Furthermore it was one of the first lenders to cut mortgage rate when FLS started in August.

• The average time lag from mortgage application to completion on purchases, which represent a large majority of current mortgage applications, is about 12 weeks. Even on remortgages in most cases the timescale is at least 8 weeks. Therefore only a small proportion of mortgages applied for in August or September will have completed within that period. It follows that it is too early to make an assessment of the effectiveness of the Funding for Lending Scheme.

“It is also worth highlighting that there is an additional very relevant factor, which has so far had very little media coverage, contributing to the significant increase in competition in the mortgage market over the last couple of months. This is a recent change of policy from the FSA, allowing banks and building societies to operate with a lower level of liquidity than previously. The result is that many lenders, particularly building societies, suddenly had additional lending capacity. In addition to increasing the amount of competition for mortgages this has reduced the need for retail savings, with the obvious impact on rates charged and offered respectively for these products.

“Mortgage rates are still falling and competition is still increasing for the above reasons. I doubt rates will fall much further but we have not yet hit bottom. A key question for lenders is whether they continue to use price as their main competitive weapon or whether they start to relax some aspects of their criteria where they have tightened more than is required by the FSA in its recently published Mortgage Market Review.

“With the funding situation improving it seems reasonable to expect a modest relaxation of criteria over the next year, resulting in an increase in the number of people who qualify for a mortgage. By widening the potential pool of customers the additional demand created by many good quality borrowers who are currently shut out of the mortgage market will reduce the need for lenders to compete so aggressively on price. Thus lenders have a choice – cut margins by offering cheaper deals or meet some of the current unsatisfied demand and hold rates or cut them by less. Furthermore any criteria changes should particularly help the politically sensitive first time buyer sector of the market, as well as others with only a small deposit.

“The increase in competition, and hence lower rates, is now becoming much more prevalent in the higher LTV sector of the market. The claim that FLS is only helping those with a large deposit can no longer be justified. For example Coventry B S is now offering a 5 year fixed rate up to 85% loan to value at 3.99% with a free valuation and no early repayment charges.”

What Should Borrowers do now?

“Although some tracker rates have fallen over the last month fixed rates have fallen further. Fixed rates were already in most cases cheaper than tracker or discount rates and so over the last month this gap has increased even further. Thus fixed rates continue to offer the best value for most borrowers, with the real choice being how long to fix for, not fixed or variable.”