Speaking at our recent conference on legal issues for mortgage lenders earlier this month, the head of the FSA’s unfair contracts team, Katherine Webster, said that individual contract terms would determine the outcome. But the FSA’s view was that it was unlikely that the possibility of the lender paying the borrower was ever contemplated when the contract between the two was agreed.
It would, of course, be irrational for borrowing to be cost-free - and even more so for customers to be paid for taking out a loan.
In the highly unusual market conditions we are currently experiencing, the reality is that the Bank rate no longer reflects lenders’ real funding costs.
With wholesale funding markets still closed, lenders are relying heavily on retail deposits and need to maintain savings rates that are attractive enough to deliver a flow of funds. In addition to covering the cost of funds, lenders must meet the costs of administering their mortgage and savings products and running their businesses more generally.
A systemic threat?
When the Bank rate falls to such historically low levels as these, margins for deposit-taking lenders come under pressure. There is a heightened risk of unpredictable movements in savings flows, which could affect future lending levels. Potentially, this represents a systemic threat. We outlined this view both in our comments to the Treasury committee earlier this month and at our annual conference in December. It has also been acknowledged separately by the FSA.
In order to protect themselves in exceptional circumstances from the possibility of market disruption, lenders often apply a collar to tracker mortgages, below which the rate paid by the borrower will no longer be pegged to Bank rate. It is important to understand that lenders may only be able to offer attractively priced products for "normal" market conditions if they are able to hedge against highly unusual market movements.
Collars are a rational and prudent form of protection for lenders - just as, in the different circumstances of rising interest rates, capped mortgages provide sensible protection for borrowers from higher mortgage costs. When rates are rising, customers choose capped mortgages for precisely those reasons.
Borrowers on tracker mortgages that may have reached their floors are now paying very low rates historically. With house prices declining, borrowers should consider taking advantage of these lower rates to over-pay their mortgages, depending on their individual circumstances. Similarly, borrowers with interest-only loans could take advantage by switching to a capital repayment option.
Fair terms
The FSA acknowledges that collars are acceptable if they are clearly explained in the sales process, and are fair terms applied fairly.
Its stance was re-iterated at our recent conference by Katherine Webster, who said: "We are not concerned with the fairness of an interest floor per se, but we do urge firms to ensure that they are drafted in a way which is balanced and fair. Furthermore, we require firms to ensure that the consumer is made aware of the existence of a floor, trigger or similar feature in an appropriate manner and at both the pre-application and offer stages."
Tracker mortgages without collars that leave borrowers paying little or no interest will please those few consumers that benefit, but do nothing to increase the flow of new lending or help stabilise the housing market and the wider economy.
It could be argued that a collar across the whole mortgage market would enable savings rates to be maintained more effectively at levels that would continue to attract new funds and maintain stability in the market for retail deposits. Clearly, however, that could only happen if the government and regulatory authorities agreed that it was fair and appropriate given the prevailing market conditions.
