• Although most of the biggest lenders have passed on last week’s 1.5% base rate cut to their standard variable mortgage rates many smaller lenders have not. And the early signs are that the interest rates on re-priced tracker products, now on offer to new buyers, have fallen by far less than base rates. So is our forecast of a 3% mortgage rate too optimistic? Perhaps, but on balance we think it is plausible.
• Our forecast, of a 3% average mortgage rate for new borrowers by late next year, implies a 200 basis point spread over base rates. Admittedly, that spread has been exceeded in the past, but only rarely. And since financial liberalisation in the early 1980s, a mortgage rate/base rate spread of more than 200 basis points has become less and less common. But, of course, these are not normal times and news from the mortgage market in recent days has pointed to upside risks for our 3% forecast.
• Tracker products were withdrawn en-mass after last week’s base rate cut. Only a few lenders have so far re-launched new products but, at best, around half of last week’s rate cut has been passed on. For borrowers with a 25% deposit, the headline mortgage rates on the new trackers are typically between 179 to 259 basis points over base rates. Clearly, with spreads already having moved sharply higher, there is no scope for them to rise further if average mortgage rates are to fall to 3%. But the good news is that, although still high, for now at least, the gap between base rates and 3m LIBOR rates appears to be closing. Given that 3m LIBOR is a benchmark for the cost of wholesale funding, if sustained, that trend should help prevent mortgage rate spreads widening further.
• But won’t mortgage rate collars stop average mortgage rates reaching 3%? A collar means that once base rates drop below a specified level, any further falls are not passed on to borrowers. For example, if a collar was set at 2.75% and the mortgage interest rate was set at 75bps above the base rate, then the interest rate on that mortgage could not fall below 3.5% (2.75% + 75bps) even if base rates were zero.
• However, before the trackers were withdrawn last week, these collars were far from universal. Although lenders such as Nationwide, HBOS and Skipton Building Society did have collars, ranging from 2.75% to 3.5%, others such as Lloyds TSB, Woolwich and Chelsea did not, while Abbey’s was set at a notional 0.001%. Encouragingly, neither Lloyds TSB nor Abbey have changed their policy on collars when re-launching their tracker mortgages this week. Of course, other lenders may not follow this example. But even if more lenders do introduce collars, we doubt they will be a major obstacle to 3% mortgage rates. We estimate that trackers represent only 10-15% of the existing mortgage stock.
• Unless there is another marked deterioration in credit market conditions, we think it is unlikely that mortgage interest rate spreads will widen significantly further. So if base rates fall to 1%, mortgage rates should fall to 3% next year. But restrictive lending criteria and the recession mean that even such low mortgage rates will not prevent the housing market correction from running its course.
