The Bank of England’s big new bank lending package should ensure that the UK mortgage crisis doesn’t get any worse.
But it won’t stop mortgages getting more expensive. And it will soon lead to cuts in the rates available to savers - so grab current 6%-plus savings offers fast.
The Bank of England (BoE) is making a massive £50 billion in extra loans available to UK banks, which can pledge top-quality AAA-rated mortgages to the BoE and get Treasury bills (T-bills) in exchange.
Abracadabra… liquidity is restored
These T-bills will have a term of one year but can be rolled over for up to three years. The banks will be able to sell these T-bills easily to generate cash they can lend.
The scheme is clever since the banks are left with all the credit risk on the mortgages – it is simply a loan swap.
Moreover, the way it is priced gives banks a strong incentive to lower the LIBOR rate at which they lend to each other, a rate which has stayed stubbornly about 1% above base rate in recent months and which needs to fall back to converge with the BoE base rate for money markets to be judged as ‘normal’ again.
The Chancellor is trying to spin this as a solution to the shortage of mortgage lending. The BoE Governor Mervyn King is keen to stress the opposite - only lending before last December qualifies, and he says the aim of the scheme is simply to restore normality to the money markets.
Normality will ease mortgage pressures
In fact, the Chancellor can justifiably argue that if normality does return to the money markets, mortgage lending pressures will ease off. At the moment, lenders simply cannot raise all the cash they need to support new lending - that is why they have been aggressively raising savings interest rates despite the latest cut in base rates. Being able to convert existing mortgages into cash will reduce this funding pressure.
But that will not mean cheaper mortgages. The banks’ profit margins on mortgages had been about 1.5% in 2000, fell to 0.3% last year at the height of the boom, and are now running at about 0.65%. The banks want to raise their margins further, and at a time when there is more demand than there is supply, that is not hard to do.
Nor will the scheme mean easier mortgages. Banks continue to tighten lending criteria - both demanding higher interest rates on mortgages above 80% Loan-To-Value and restricting maximum loans using lower income multiples or tighter ‘affordability’ criteria. And they will continue to raise the interest rate premium payable by anyone other than top-quality borrowers.
We’re in a sellers’ market for mortgages
Essentially, last year UK residential mortgages were a buyers’ market but now they are a sellers’ market. There aren’t enough to go round. Overall lending capacity in the UK, even taking into account the new BoE lending facility, is probably £20-30 billion short of potential demand. That can only be resolved by the reopening of the ‘mortgage securitisation’ market that closed down after the Northern Rock debacle.
That may happen by the autumn, because provided investors are confident that the label does describe accurately what’s in the tin, buying a package of triple-A residential mortgages to get an income of 6.25% is still an attractive proposition if the Bank rate is 5.25% - or 5%, which is what it will likely drop to in the next couple of months.
I wouldn’t be surprised if banks even tried to sell such mortgage packages back to us - or rather, to those with capital they want to earn a high income from, namely retired people, who are short of good income-producing investments.
Grab longer-term 6%-plus offers now
Meanwhile, it is savers who need to get their skates on. The BoE scheme will reduce pressure on banks to raise money from depositors. As banks secure loans from the BoE they will need to raise less from us.
That will almost certainly lead to cuts in savings rates, though not from the smaller banks or building societies which will have limited ability use the BoE facility.
So I recommend that you act soon to lock in a good rate on your cash. Do not be too swayed by variable rate offers – banks will cut rates as soon as they can get away with it. I recommend longer-term accounts for one to three years, since I very much doubt if you will be able to get anything like 6% on such accounts by this autumn.
If you have rainy day cash you can lock away for longer, go for one of these fixed rate accounts. You can get as much as 6.8% from Icesave, Birmingham Midshires and Heritable Bank for 1-2 years, or 6.4% for one year from Nationwide.
See all our best buy fixed rate savings accounts
