25 Year Fixed Rate Mortgages
Gordon Brown is set to shake up the housing market with his promotion of long term, fixed rate mortgages. But will the UK public be willing to give up the lure of short term, low interest rates for the security of a long term, fixed rate?
Let's look at an example:
Jo and Joanna are first time buyers. They have managed to find a nice little two bed apartment for £140,000. Now, should they choose a discounted mortgage which starts at a rate of 5.36% or should they choose a 25 year fixed rate mortgage at 6.39%? Luckily, Jo and Joanna are quite financially savvy, so they have decided to check out the overall rate. They discover that the discount mortgage averages out at 6.7% over the life of the mortgage, assuming interest rates don't vary, which of course they will. If they choose the fixed rate mortgage and interest rates drop they might lose out. If interest rates stay the same or rise then the fixed rate mortgage is a clear winner. But hold on a minute, there's always mortgage hopping to consider. They could go with the discount mortgage, then move to another discount mortgage as soon as the tie-in period is up. And in the back of their minds, Jo and Joanna are both pretty sure that their income will continue to go up, so really, it's a cheap mortgage now that's most important to them. Like the vast majority of borrowers in the UK, Jo and Joanna go for the discount mortgage.
So why does Gordon Brown want to change this? Well, because he believes that the volatility of the housing market is largely responsible for the economic ups and downs often experienced in the UK. His overriding concern is to settle the market down into a slow but steady growth pattern. Given the chance, he would like to erase the phrase ‘negative equity' from the public mind forever. And the secret weapon for achieving this is the covered bond.
What is a covered bond? Basically covered bonds are created when a number of financial institutions (or governments) pool products, typically mortgages, together to cover for each other. If one of these institutions were to get into financial difficulty, any bonds they had sold would be covered by the revenue obtained from the other bonds in the pool. The secure nature of covered bonds make them a cheaper borrowing option.
Over the last fifteen years, covered bonds have really taken off in Europe, with Germany in particular leading their development. However, legislation in the UK has lagged behind and at present covered bonds issued in the UK are not recognised by the EU. This is what Gordon Brown plans to change. New legislation, including changes to the way covered bonds are entered in company accounts, will put the UK on an equal footing with other parts of Europe. Gordon Brown is hoping that mortgage lenders will take advantage of this relatively cheap and very secure method of lending to offer home buyers long term fixed rate mortgages.
He also plans to increase the amount of money that banks and building societies can raise on the financial markets, again giving them more stability and flexibility to plan for long term lending. In theory, this should then encourage lenders to offer long term fixed rate mortgages at a lower interest rate than is generally available at the moment.
Of course, Gordon Brown could be defeated by his own success. If people believed that interest rates were going to soar within the next twenty years then long term, fixed rate mortgages would become instantly popular. However, if, as Mr Brown hopes, stability in the housing market leads to overall stability in the UK economy, then there should be fewer fluctuations in interest rates. Mortgage rates should stay the same, and might even fall. If borrowers believe this then they will not want to tie themselves to a twenty five year fixed rate.
Despite Mr Brown's intentions, many people still believe that those discount mortgages will continue to be the first choice for most people.
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