The Government bailout and emergency rate cut signal light at the end of the tunnel for mortgage borrowers.
First things first, let’s not carried away. The UK mortgage market is still in dire straits. Lenders are folding on a weekly basis, both the household names we thought could never collapse and lesser-known “sub-prime” brands that don’t make the headlines.
Lenders are still only offering decent deals to low-risk borrowers and have pulled back much of their buy-to-let lending. And, of course, if you’ve a bad credit history you can forget it. In addition, arrangement fees can be astronomical and margins between Base Rate and pay rates are particularly wide.
According to Defaqto, margins are significantly wider now than they were the last time Base Rate was at 4.5% (August 2006). Then, an average two-year fixed rate was 5.29%, just 0.79% above Base Rate, whereas yesterday, before the cut, an average two-year fix was 6.33% (which was 1.33% above the 5% Base Rate).
In other words, two-year fixed rates have increased by 0.54% relative to Base Rate. The figures show that two-year trackers have increased by 0.73% relative to Base Rate and two-year discounts by 0.85%.
But these figures offer a snapshot of the market before the big rate cut and bailout, and the coming weeks could well provide a different landscape.
So how will the cut affect borrowers?
Those borrowers on a tracker rate will see their pay rate drop immediately, or by next month, by 0.5%.
This will bring immediate relief for the 4.2 million borrowers with tracker mortgages (36% of the mortgage market according to some reports), who will see significant monthly savings.
For an average repayment mortgage of £150,000 on a tracker rate over 25 years, the immediate saving is £43 per month, with payments reducing from £876 per month to £833.
Those borrowers on standard variable rates, or discounted rates linked to SVR, could also be in for good news -- but only if their lender passes on the full cut.
Some of the country’s biggest lenders, including Lloyds TSB, C&G, Halifax and Barclays Woolwich have already announced they will pass on the full 0.5%, bringing relief to many borrowers, with more lenders expected to follow.
The big question is fixed rates, which are more heavily linked to swap rates than Base Rate, as they reflect the cost of fixed term borrowing for lenders. Happily they have also gone down this week, dropping dramatically to 4.95% on Monday (from 5.6% last month), in anticipation of the rate cut.
If swaps remain low following the double Base Rate cut, fixed mortgage rates could well go below 5% in the next two weeks, according to some experts, which would be a massive boon for borrowers. Remember that swap rates have been all over the place this year though, so there are no guarantees.
Bailout helps borrowers
It’s not just the Base Rate cut that will have a positive impact on mortgage borrowers. The bailout announced yesterday by the Government, including recapitalisation of the high street banks and the pumping of more funding into the banking system will impact on the mortgage market too -- injecting some much-needed confidence.
Indeed, if lenders can restore liquidity and crucially confidence, the system can begin to get moving again. Eventually this should allow lenders to price more aggressively and extend this competitive pricing to those with smaller deposits, rather than just remortgagors with large amounts of equity in their homes.
But while events this week's events offer some light at the end of the tunnel, there are still potential problems.
Lenders are still very wary about higher risk borrowers and it is difficult to gauge whether this will change in the foreseeable future, regardless of their funding position.
They will also have service issues if the market picks up too quickly. The last year has seen many redundancies in the sector particularly in processing centres as business levels have dropped off. They would have to be managed carefully upwards to prevent lenders being flooded with applications. There are no quick fixes to the current mortgage problems.
Some commentators believe that more cuts are needed and that Base Rate should be brought to 4% or even 3.5% in order to really boost confidence and encourage interbank lending.
What should borrowers do?
As has been the case all year, trackers are still looking extremely attractive, particularly following the rate reduction. Some lenders, including Nationwide and C&G offer a drop lock option, enabling borrowers to take out a tracker and switch to a fixed rate without incurring early repayment charges. This could be a good option as fixed rates may be set to come down in the near future.
In my opinion, you should only fix now if you need to get your mortgage or remortgage immediately and cannot afford for rates to increase at all. At the moment fixed rates are not competitive against trackers and might be reducing in the next few months. But this year has been one of surprises, so above all, choose the mortgage that best suits your needs and that you can afford to repay -- and do not try to play the market.
This week may end up being seen as the final turning point of the credit crunch - but if the mortgage market has shown us anything this year it is to expect the unexpected.
More: Trackers Vs. Fixed Rates
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