Paul Diggle, property economist at Capital Economics, said that whilst this may be further evidence of the low esteem in which the financial services sector is now held, it misses two key points.
First, after a period in which lenders systematically underpriced risk, a rise in the relative cost of mortgages was both inevitable and desirable. Second, with mortgage interest rates at an all-time low, it is access to credit rather than its cost which is the more important factor in explaining the low level of housing market activity.
Commenting, he said: “Interest rates on new mortgage lending are historically high in relation to Bank Rate. For example, the spread between the interest rate for a new tracker mortgage and the Bank Rate was 3% in August. The average spread between 1997 and 2007 was 0.9%.
“The media’s interpretation is that this is evidence that banks are setting mortgage interest rates on new borrowing excessively high in order to increase profits. An alternative explanation is that much of the rise in spreads can be accounted for by the more realistic pricing of risk.
“However, such factors are not a complete explanation. As operating costs are likely to have remained relatively constant recently, this implies that at least part of the rise in the mortgage interest rate/Bank Rate spread reflects higher margins. While one explanation of this is profiteering, it is important to remember that lenders’ margins on new lending could be elevated because the profitability of existinglending has been squeezed, for example by contractual obligations to pass on reductions in Bank Rate, and competition to attract retail deposits.
“Borrowers are still benefiting from those years of excess. The average floating rate on existing mortgages, at 2.8%, is lower than the average floating rate on new advances, at 3.25%, for the first time on record.
“Although it may seem unfair that new borrowers are being penalised for the benefits enjoyed by their predecessors, the rise in mortgage rates relative to Bank Rate is part of the adjustment process that the UK banking system has to go through.
“In any event, with new mortgage interest rates at an all time low, the cost of the penalty being borne by new borrowers is hardly onerous and is unlikely to explain the current low level of activity in the housing market. To the extent that new mortgage interest rates now more realistically reflect risk, this should arguably be welcomed as contributing to increased financial stability.
“The debate around high lending spreads would do well to remember where cheap credit got us to in the first place.”
