The most interesting question about fixed-rate mortgages, about which Professor David Miles of Imperial College London produced a long report for the Government this week, is not why do we not have more long-term fixed-rate deals in this country. The interesting question is when, if ever, as a borrower and homeowner, is it right to take one out?
This is not such a stupid question as it might seem. The argument for long-term fixed-rate deals is, as Professor Miles makes clear, an argument for taking out insurance against future unexpected interest rate rises. The rationale has to be that the adverse impact of finding interest rates rise against you is potentially so severe that it is worth paying more to avoid that.
But as with all types of insurance, the benefit has to be proportional to the cost to make the exercise worthwhile. The reality is that for most of the past 20 years, taking out a fixed-rate, long-term mortgage, had they existed, would have been a terrible idea. This is not just because fixed-rate mortgages have tended to be more expensive than alternatives, though they have been. It is also because interest rates in general have been in a downward trend for at least 15 years, thanks to policymakers' success in bringing inflation under control. The premiums for insuring against interest rate rises have therefore, de facto, been high.
What is more, this secular interest rate trend, which took time to be accepted by many professional investors, has been widely understood and appreciated in recent years. You can go to the back of the newspaper any day of the week and see from the money markets what future interest rate expectations are today.
There is, as yet, no sign of a powerful uptick in inflationary expectations. My experience looking at the price of fixed-rate mortgages regularly over the past few years is that there have been only brief periods when the markets have indicated a fixed-rate mortgage would be the best answer. The rest of the time, to have a good reason to take one, you would have had to make an active bet that the money markets were wrong about their interest-rate expectations, which is a brave assumption.
This is not to say such reversals in expectations do not happen, or that the markets are invariably right about the future course of interest rates; far from it. But most homeowners who opted for a fixed-rate mortgage have not been doing themselves a favour. If fixed rates look cheap, it is usually because long-term interest-rate expectations are low. But if that is the case, why bother to insure yourself in the first place? There will be times when interest rates rise and leave those with fixed-rate deals looking smart for a while. But again, how often will that happen?
As with most insurance, the risk is that you end up paying too much to protect yourself against a risk whose odds and frequency are less than you think. The best defence against being caught out by interest rate rises is not to borrow too much in the first place. The form the mortgage takes is of secondary importance.
Another thing to remember about mortgages is that in the end, the litmus test is not the cost of the borrowing, but how that cost relates to the growth in value of your house. In other words, if house prices are still growing at 9 per cent per annum, and you are borrowing at 5 per cent, a 0.5 per cent difference in your borrowing costs is not material. Whether that kind of growth rate is still achievable is doubtful, given where house prices are, but the point remains that the cost of your mortgage is a second order item. Your view about house prices should come first and your mortgage option second.
In response to readers' requests, I offer thoughts on the best investment books of the year. This has not been a bumper year by any means, but the following are all titles I found well-written and interesting, and which have provided me with valuable insights.
They are: Money For Nothing, by Roger Bootle (Nicholas Brealey); Adventure Capitalist, by Jim Rogers (Wiley); and Fools Gold, by Marc Faber (CLSA Publishing). It may just be an accident, or prejudice on my part, but two of the three say commodities and Asian markets are going to be places to look for strong returns in the coming years, an argument any investor needs to be aware of. For something rather different, or perhaps a stocking filler, I nominate Logic Problems for Money Minds, a collection of verbal or numerical brainteasers published by Harriman House, from whom all the above titles can be ordered. Phone 01730 233879 and mention The Independent.
Here is a sample question. A library has 1,400 regular users. It decides to get rid of its surplus books. It offers six to each female borrower who applies and four to each male borrower who applies. Half the women borrowers and three quarters of the men take advantage of the offer. How many books does the library give away?
Although you do not know how many male or female borrowers there are in the 1,400 universe, the answer is quite easy if you are still in touch with your algebraic feelings, but might detain you otherwise. Answers when this column returns in the new year.Reuse content