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Dave Beans

Why The British Do Not Have 40 Year Fixed Rate Mortgages

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Interesting article

http://www.telegraph.co.uk/finance/personalfinance/borrowing/mortgages/10594494/Why-Britons-cant-have-40-year-fixed-rate-mortgages.html

In many parts of the world, house buyers can rest assured that their mortgage rates won’t change for decades. Now British lenders are coming under renewed pressure to introduce deals that fix rates for 25 years. This would provide certainty around future repayments and may even help make the property market more stable. Interest rates are expected to rise towards the end of this year or in early 2015. However, some experts are predicting earlier rises after unemployment data published this week showed unemployment fell to 7.1pc. This is just 0.1 of a percentage point above the level where the Bank of England said it would begin considering raising interest rates, although the Bank has dropped heavy hints that a rise is not imminent.

There are fears that when rates do go up, many borrowers who have short-term fixes or variable rate mortgages could struggle to afford the higher repayments. Earlier this month the Bank of England said home owners faced a “real risk of exposure to rising interest rates” in the coming years, which could be removed by “locking in” mortgage rates.

Richard Sharp, an external member of the Bank’s Financial Policy Committee, said: “Certainly, the structure of the UK would have lower risk associated with the housing market if more mortgages were fixed, and fixed for longer.”

While long-term fixed rate mortgages are common in other countries, they have never been popular in Britain.

Where long-term fixes thrive

Longer mortgage deals are common in the United States, Denmark and France, where borrowers can lock in for up to 40 years. In the US, the vast majority of mortgages are fixed for 15 or 30 years. Lenders do not levy early repayment charges so borrowers don’t need to worry about the cost of paying off their mortgage early if they move home or want to change lender. This means there is very little risk to borrowers of taking out long-term loans.

In Denmark, fixed-rate deals that run for 30 years are common. Special mortgage banks act as an intermediary between borrowers and investors who fund the loans by buying bonds. Borrowers make principal and interest payments to mortgage banks, which transfer the amounts to investors, minus administration charges. Borrowers can repay their loan in full at any time at the current market rate.

In France, mortgages are typically fixed for 20 years. Borrowers can fix for a shorter term, but must pay a mortgage registration tax of roughly 1.5pc, which discourages regular remortgaging. Early repayments incur a 3pc fee in many cases. However, there are some French mortgages that have no early redemption penalties.

Why hasn’t it worked in Britain?

Customers, firstly, are to blame, say lenders. There’s not enough demand because borrowers prefer the flexibility of being able to switch deals. It has been tried before. In 2007 Gordon Brown, then prime minister, said he wanted to make longer fixes more available.

Nationwide responded with a 25-year fix that cost 6.39pc. During the first 10 years of the loan, borrowers faced an early repayment charge of 3pc. Halifax followed with a 6.39pc 25-year fix, with identical penalties. At the time, the Bank Rate was 5.5pc and two and three-year fixed rates were hovering around 5.75pc. Other 25-year fixes were also available from building societies such as Kent Reliance and Scarborough. All had hefty early repayment charges and demand was low, so the products dwindled out.

The last lender to launch a 25-year deal was Manchester Building Society, which introduced a 5.24pc fix in August 2012. The loan came with early repayment charges of 1.5pc for the first five years and 0.75pc for the next two. It is no longer available.

Ray Boulger of brokerage John Charcol said lenders would need to remove or limit early repayment charges to attract borrowers. This would give more flexibility if their circumstances change and they need to move house, go through a divorce, repay the loan more quickly, or remortgage at a better rate. The main barrier at the moment, said Mr Boulger, is that longer deals put more pressure on lenders to hold capital.

Another argument is that much profit from mortgages is generated in the form of upfront fees, rather than being built into rates. And mortgage brokers, who only make money when new loans are sold, are also arguably unlikely to recommend arrangements whereby they would never service their clients again.

What are the benefits and risks to borrowers?

The main benefit for borrowers is certainty around repayments.

Borrowers are not affected by changes to interest rates and volatility in the wider economy and can be sure their repayments will not rise during the term of the loan. It also eliminates the costs that come with regular remortgaging.

Some argue that long-term fixes take a lot of volatility out of the mortgage market – people do not struggle to pay their mortgage when rates go up, limiting defaults.

But some borrowers have paid a high price for this certainty. Those that fixed in 2007 at 6.39pc lost thousands of pounds when interest rates plummeted to their current low of 0.5pc.

The lack of flexibility also meant that borrowers who wanted to move to a cheaper rate, sell their house or pay off their loan faster were hit by substantial early repayment fees, trapping some in costly long-term deals.

Edited by Dave Beans

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For some reason, the only reaction that this solicits in me is that in 2004 when the Miles report trod the same ground the 2008 crash was four years off and the 1989 crash was 15 years in the mirror. Hence this new boom-bust cycle is going to be smaller magnitude in price terms and shorter in duration.

Working the same ratios

1989 to 2004 - 15 years

1989 to 2008 - 19 years

2008 to 2014 - 6 years

6 years divided by (15 years/19 years) implies house price crash 7.6 years forward from 2008 - say 2015, 2016.

Mostly tongue in cheek, natch!

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For some reason, the only reaction that this solicits in me is that in 2004 when the Miles report trod the same ground the 2008 crash was four years off and the 1989 crash was 15 years in the mirror. Hence this new boom-bust cycle is going to be smaller magnitude in price terms and shorter in duration.

Working the same ratios

1989 to 2004 - 15 years

1989 to 2008 - 19 years

2008 to 2014 - 6 years

6 years divided by (15 years/19 years) implies house price crash 7.6 years forward from 2008 - say 2015, 2016.

Mostly tongue in cheek, natch!

Very tongue in cheek! But would be nice if it did work out like that! I'll be bookmarking this post! B)

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if the average UK FTB is 38, id say its pretty self explanatory why we dont have 40 year mortgages.

:lol:

That too! (Of course, if we pushed the retirement age to 78 and mortgages to 40 years we could solve two problems at once... :ph34r: )

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It's not just about "40 year mortgages", though. The idea of a fixed-rate mortgage for the duration is quite appealing, except that if the BoE base rate stays low for a long period of time, people are going to feel hard done by - even though they have the advantage of knowing their mortgage payments are fixed whatever happens.

What I don't understand is, if the "vast majority" of mortgages in the US are fixed, what's the point of having a central bank dictating interest rates? That again highlights, to me, that the official bank rate (at least in the US) is really of more relevance to the US Government than to the ordinary person.

Anyway, I guess the cost of money is going to remain low while they're still pumping out QE money at a rate of $75 billion every month.

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A work colleague in the 70's had a 25 year fix. IRs had risen and he and his wife wanted to move but couldn't bring themselves to pay the now higher rate on a new mortgage.

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It's not just about "40 year mortgages", though. The idea of a fixed-rate mortgage for the duration is quite appealing, except that if the BoE base rate stays low for a long period of time, people are going to feel hard done by - even though they have the advantage of knowing their mortgage payments are fixed whatever happens.

What I don't understand is, if the "vast majority" of mortgages in the US are fixed, what's the point of having a central bank dictating interest rates? That again highlights, to me, that the official bank rate (at least in the US) is really of more relevance to the US Government than to the ordinary person.

Anyway, I guess the cost of money is going to remain low while they're still pumping out QE money at a rate of $75 billion every month.

whatever floats you boat...

personally i find the idea of no mortgage or a very short one more appealing.

If house price bores relation to construction costs and building land permissions werent monopolized by govt, a 5-10 year total mortgage term would be entirely possible. Just wouldnt suit the city.

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whatever floats you boat...

personally i find the idea of no mortgage or a very short one more appealing.

If house price bores relation to construction costs and building land permissions werent monopolized by govt, a 5-10 year total mortgage term would be entirely possible. Just wouldnt suit the city.

A 5-10 year mortgage will give you some leverage vs an all cash purchase in exchange for a modicum of risk. In the unlikely event that I buy a house in the UK that would be my choice too.

The UK generates a greater share of its GDP through HPI over the housing cycle than any other comparable economy which is why we can't have fixed rate mortgages, or the euro for that matter. The City rentier economy is responsible, of course.

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