Mortgage Advice Centre

The new reality of government owned banks is starting to affect the mortgage market.

On Nationalising Northern Rock, the government wanted Northern Rock to run down its mortgages and pay back the government loan as quickly as possible. However, with the mortgage market seemingly frozen ( In December only  31,000 new mortgages were approved (compared to an average of 104000 in 2007)) the government have asked Northern Rock to start lending more mortgages - £5bn this year and £9bn in 2010.

Some of the mortgages will be for 90% mortgages. i.e a deposit of just 10%. This may help increase competitiveness for those with a relatively small mortgages. Currently fixed rate mortgages on 90% mortgages are over 6% and are not very competitive. It is good news for first time buyers who struggle to save more than a 10% mortgage.

The government has promised that there will be no return to 100% mortgages, even though in a climate of falling prices, there are not lender who actually wants to give this kind of mortgage.

Whilst this might seem good news for a depressed housing market, it will be interesting to see how government intervention in the mortgage market continues in the long run. Many blame the US sub-prime mortgage crisis not just  on financial deregulation but also government initiatives to encourage Freddie Mac and Fannie Mae to extend mortgages across the whole population.

True the banks have failed to manage their mortgage accounts but will the government owned banks do any better? Let’s hope so. The new mortgages are said to be available in April of this year

Lloyds Banking Group, the owner of the UK’s biggest lender, Halifax, and Cheltenham & Gloucester,has stated that now could be the best time to get a fixed rate mortgage. They say that fixed rate mortgages are unlikely to go any further down.

The best rates on a  fixed rate mortgages are as low as 2.99%. This is for people with substantial deposit and perfect credit history. However, compared to the past 10 years, these rates are low. The average fixed rate for the past 10 years is 5.84%

Standard variable rates which offer the base rate plus 1% give an interest rate of 2%

There is a temptation to get a fixed rate of 3%, it offers a very good guaranteed interest rate for the next two years. However, the prospect for base rates still suggest they could fall further to 0%.

The difficult issue is knowing how long interest rates will stay so low - so close to 0%. For example, in Japan they had interest rates of 0% for many years.

If the bank pursued quantitative easing increasing money supply then we could get a return of inflation by 2010, this could lead to interest rates rising fairly significantly. But, given state of economy it is hard to imagine interest rates rising for the foreseeable future.

It is possible fixed rates could continue to fall over 2009. But, this could be an excellent year to get a 5 year or 10 year fixed rate mortgage

UK interest rates

The Bank of England’s inflation report gives a strong indication that interest rates in the UK could fall to 0 - 0.25%. There is also an increasing likelyhood of quantitative easing - a policy of creating money to avoid the deflationary impact. (B of E report)

The UK is facing its deepest recession since the Second World War (Not for 100 years as a government minister Ed Balls suggested). GDP is forecast to decline by 4% this year, and there is a prospect for further falls if the global economy continues to decline. Combined with falling commodity prices, the high levels of spare capacity is leading to a significant fall in inflation. The Bank forecast inflation of 0.6% this year. If the economy fails to recover in 2010, we could be faced with deflation - something which could be very damaging for the economy.

What is Effect of 0% Interest Rates?

Those with variable mortgages, especially tracker mortgages will be facing very low payments. There is even prospect of some tracker mortgages with 1% off base rate having to pay mortgage holders! (I’m not sure whether banks can get out of that or not, it depends on fine print. Suffice to say when banks offered tracker mortgage deals of 1% of base rate they never anticipated 0% interest rates

Savers will face very limited returns. Savers will struggle to find accounts which offer a decent return. However, many banks are still looking to attract more deposits, so some accounts will offer significantly above the 0% base rate.
The good news for savers is that the fall in inflation will help increase the real interest rate. Currently we have negative interest rates (inflation is above base rates) but the fall in inflation will mean real interest rates will improve. This is good news for savers, though people tend to just concentrate on the nominal interest rate and not real interest rates.

Problems of 0% interest rates

• Banks may struggle to attract deposits. E.g. people keep more cash or buy gold. This could make less deposits available for new mortgages
• Banks may not pass rate cuts onto consumers. Monetary policy becomes ineffective.
• Quantitative easing is unknown territory. It could be inflationary in the long term. Though the threat of deflation could be damaging for UK economy.

Graph showing Real Interest Rates

Real Interest rates in UK

Source: Bank of England, 2005, p. 11, Chart 3 via - open learning

Real interest rates is the official interest rate - inflation.

If interest rates are 1% and inflation is 0.2%. Then the real interest rate is 0.8%

If interest rates are 12% and inflation is 13.5%. Then the real interest rate is -1.5%

In other words, a saver is better off with interest rates of 1% and inflation of 0.2%

At the moment, we have negative real interest rates because the base rate is 1% and inflation is 4% (though coming down)

However, many commercial banks have not followed the base rate down. So savers can still find saving accounts which offer a positive real interest rates.

The real interest rate is important for determing the real cost of borrowing and saving. A high real interest rates will, ceteris paribus tend to discourage borrowing and spending.

However, in a credit crunch a negative real interest rate may still be insufficient to encourage borrowing and lending because there is a shortage of credit.

See also: Historical interest rates

Readers Question: How can I find data on Historical interest rates nominal and real

Graph of Interest rates since 1985

UK Interest rates graph

source: House web

Real Interest rates

See: Real interest rate history in UK

Other links for Info on Past interest rate trends

• The Bank of England provide detailed interest rates since 1963 [B of E link]
• e.g. Official interest rates since 1975 at B of E
• Interest rates since 1991 at Guardian

International interest rates

G7 interest rates

US Interest Rates

US interest rates

• Mortgage interest rates explained
• Historical House prices

Halifax posted a surprise rise in house prices during January.

• Figures suggested house prices in January rose 1.9% in January reversing the 1.5% fall in December.
• This comes on the back of data showing an increase in mortgage approvals and activity in the housing market.
• Combined with record low levels of interest rates, Halifax have said that buying a house is becoming increasingly attractive to first time buyers.
• Whilst the rise in house prices will be a welcome boost to confidence and may encourage more to consider buying, it may prove to be just a statistical aberration. Traditionally, month by month house prices can be volatile. In the last period of falling house prices (1989-1993), there were months of price rises amongst the larger deterioration in average house prices. See historical house prices in UK
• A better guide can be gained from looking at a 3 month trend in house prices which show a continued deterioration. The year on year fall of house prices is 17%.
• Nationwide data showed falls in house prices in January.

• House prices in the US have been falling for 3 years, though there is a greater problem of excess supply in the US

“It was the best of times, it was the worst of times”

There is no doubting that the UK housing market is facing the worst of times with rising repossession, falling house prices and a collapse in property transactions. But, amidst all the doom and gloom, some mortgage owners will have to admit they have never had it so good. Interest rates are at a record low. It means that those on variable mortgages are benefitting from a substantial fall in monthly payments. Even if your bank is reluctant to pass on full rate cut, interest payments have fallen significantly.

For those lucky enough to choose a tracker mortgage, they are facing the prospect of £0 interest payments. This is a huge rise in disposable income. It is a complete contrast to the last housing crisis when interest rates reached double figures causing mortgage payments to become unaffordable.

However, whilst existing homeowners benefit, this does little if anything for those on the outside. Mortgage payments may be very low, but, the difficulty is getting a new mortgage at all. In fact some banks and building societies are complaining that with interest rates so low they can’t attract savers and gain the funds to lend new mortgages. With house prices falling, mortgage lenders are taking the extra precaution of asking for a big deposit. It is this difficulty of getting a mortgage that has caused a dearth of first time buyers, a fall in property transactions and falls in house prices.

However, amidst all the unrelenting grim news, there was a little recovery in December. The number of approved mortgages rose for the first time in many months (admittedly from a very low base)

The Bank said net lending was 1.9 billion pounds ($2.7 billion) in December compared to 834 million pounds in November.

That was still way below levels a year earlier. In December 2007 net lending was 7.7 billion pounds.

This may be a one off blip. But, if it is the start of recovery in mortgage lending that would be very good for the housing market.

As the Halifax points out, mortgage affordability for first time buyers has improved significantly in the past 18 months. Nevetheless, some still predict large house price falls because of the moribund nature of the mortgage lending market.