Home loans kept artificially high as lenders 'profiteer'

Interest rates are at a record low, but mortgages are getting more expensive. Chiara Cavaglieri and Julian Knight explain why

Banks and building societies have been accused of fleecing homeowners and potentially thwarting any chance for a housing market recovery.

They are doing this by increasing mortgage rates, despite seeing their own lending cost fall to its lowest rate in over 20 years. Figures compiled by comparison site Moneysupermarket for the IoS show the extent to which lenders are ripping off customers by keeping mortgage rates artificially high.

Usually, mortgage rates move in line with the London Interbank Offered Rate (Libor) – the cost of borrowing in the wholesale funding market. In July 2008, the average three-year fixed mortgage was 6.66 per cent, while the Libor was at 5.89 per cent, giving lenders a margin of 0.77 per cent. Similarly, the average rate on a two-year tracker mortgage was 5.99 per cent, reducing the margin to only 0.1 per cent. The figures one year on, however, paint an altogether different picture. The Libor is now at a record low of 0.99 per cent, and with the average two-year tracker at 3.27 per cent, there is a margin of 2.28 per cent. Even more dramatically, the average rate on a three-year fixed mortgage has shot up to 4.59 per cent, increasing the margin to 3.6 per cent.

"Lenders are really looking for every opportunity to make more profit. At the moment, there is more demand than supply, so if they can get away with charging higher interest rates, they will," says Louise Cuming, mortgage expert at Moneysupermarket.

When the Libor fell below 1 per cent, it reached its lowest level since it was set up in 1986; at the same time, the Bank of England kept the base rate at just 0.5 per cent. Despite being able to borrow money cheaply, lenders have not passed on these savings. Quite the opposite, in fact, with many lenders taking advantage of demand outstripping the number of deals on offer and pushing prices up.

Fixed-rate mortgages have seen some of the most significant increases in the past month. Lenders were quick to pass on the increase in the cost of wholesale funding last month, when five-year swap rates, the price at which lenders can borrow at a fixed price over a specific period of time, peaked at 3.83 per cent in June. However, fixed-rate mortgages showed no sign of falling back in line after swap rates fell. The nationalised bank Northern Rock, for example, recently increased its five-year fix by 0.6 per cent to 5.89 per cent.

"When lenders were falling over each other trying to increase fixed mortgage rates last month, their response was that they had no alternative, that this needed to be done due to higher swap rates, and competitors were doing the same. When the same swap rates subsequently fall, mortgage rates and pricing seem to become disjointed from these benchmarks altogether," says Darren Cook, from comparison site Moneyfacts.

Building societies in particular have made the decision to increase mortgage rates, choosing instead to focus on their savings products. During the past month Cheshire Building Society has increased its trackers by up to 0.24 per cent, Woolwich has increased them by up to 0.30 per cent, and rates on trackers from Chelsea Building Society are up by as much as 0.20 per cent. In many cases, price hikes are intended to make products artificially unattractive because some lenders simply don't want the business.

"Building societies are a different animal. They haven't benefited from any of the bailouts that banks have had and they certainly aren't chasing borrowers. They don't want to increase their borrowing books and they're concentrating on savings rates," says Ms Cuming.

But building societies aren't just guilty of keeping the rates on new deals artificially high: loyal customers on standard variable rate deals are also feeling the pinch. According to Moneysupermarket, the average standard variable rate among the banks is currently 3.97 per cent – nearly 3.5 per cent above Bank of England base rate, but building society customers have to pay a whopping 4.97 per cent. To put that into pounds: repayments on a 25-year, £150,000 average standard variable-rate mortgage with a bank would be £797.61; with a building society it would be £884.24.

The Council of Mortgage Lenders (CML) has defended banks and building societies for keeping rates high, explaining that the Libor and swap rates are not the only influence on pricing, but rather they are part of a "complex jigsaw" of factors. A CML spokesperson says: "Simply looking at the swap rate does not account for the fact that not all lenders will be able to raise funds at interbank rates, especially in the current environment."

Andrew Montlake, director at mortgage broker Coreco, thinks the CML has a point, particularly when it comes to building societies: "Getting the funds is the real problem for smaller lenders. If the money markets aren't open for them, they have to rely on institutions and they tell me that the terms and conditions keep changing and the expense keeps going up."

But Mr Montlake does think there is profiteering going on: "There is some bumping up of margins and repairing of balance sheets going on, but it is a little simplistic just to point at Libor, then point at the mortgage rates on offer to say that the lenders are simply making a killing. Hopefully, we are at the tail end of the credit crunch, but it's still very difficult."

David Hollingworth, from broker London & Country, argues that another factor is that lenders are wary of attracting business they cannot cope with. "There remains a very limited appetite for mortgage lending and, as a result, lenders are very aware of how they price their products so as to attract the right level of business." A surge in business can cause processing problems and difficulties in managing the volume. "Therefore, many lenders will reprice to move away from best-buy territory and the big volumes that come with it," he adds.

Another aspect could be that lenders did not foresee the bank rate hitting the record low of 0.5 per cent and are trying to recoup losses on tracker and standard variable-rate products with higher rates for new customers. "It could be argued that they have no alternative but to stick with these low rates for their existing borrowers. The downside is that new borrowers look as if they are unfortunately picking up the tab for this," says Mr Cook.

The disparity between the best products available and the worst is another important issue for homeowners. At the moment, the Co-op Bank offers one of the best tracker deals on the market at 1.89 per cent above Bank of England base rate for three years with a £995 fee and up to 75 per cent loan to value (LTV). With Libor at 0.99 per cent, that leaves a margin of just 1.4 per cent. Unfortunately, the best deals are only available to people with substantial deposits and pristine credit records.

While there will be many existing borrowers currently paying around 1 per cent or less on their tracker rate mortgage, for new borrowers the mortgage market is a minefield, with a colossal disparity between the best rates available and the worst. Homeowners unable to pool together funds for a large deposit will see the best buys slip away and rates begin to rocket. Woolwich, for example, increased the five-year fix at 80 per cent LTV from 6.29 per cent to 6.49 per cent, compared with the rate at 70 per cent LTV of 5.19 per cent. Also, just a few days ago Abbey repriced several products including the three-year fixed rate at 85 per cent LTV, which increased from 5.74 per cent to 5.99 per cent.

"It remains true that the rates on offer are very much tiered, depending on the level of deposit or equity. Lenders continue to offer more favourable deals to those with at least 25 per cent deposit and in some cases 40 per cent," says Mr Hollingworth.