Loyal mortgage borrowers subsidise new customers

Millions of homeowners are paying billions of pounds extra for their loans to subsidise cut-price deals for new customers, a government report found yesterday. In a critique of the state of Britain's mortgage market, Professor David Miles found that lenders were using profits from existing customers to subsidise cheap deals to attract new borrowers.

Millions of homeowners are paying billions of pounds extra for their loans to subsidise cut-price deals for new customers, a government report found yesterday. In a critique of the state of Britain's mortgage market, Professor David Miles found that lenders were using profits from existing customers to subsidise cheap deals to attract new borrowers.

Professor Miles said that while the mortgage market was not anti-competitive, it was not serving some borrowers as well as it could. He held out the threat of recommending an investigation into overcharging by the Office of Fair Trading (OFT) and the Financial Services Authority (FSA) when he produces his final report next spring.

"I will consider whether in my final report I should include a recommendation for action from the FSA or OFT under their respective powers," he said.

Professor Miles, an expert in housing finance at Imperial College, London, was asked by Gordon Brown, the Chancellor, to examine why so few Britons took out long-term fixed rate mortgages. Mr Brown said he was worried the concentration on variable and short-term fixed mortgages was responsible for the UK's history of "stop-go" economic problems - a barrier to entry into the euro.

Professor Miles's 124-page report found borrowers attached a greater weight to the level of initial monthly repayments than to the overall cost of the loan over the life of the mortgage. "Many people perceive the costs of the mortgage as the level of the first monthly repayment," he said. "This means that longer-term fixed rate mortgages appear expensive when compared with discounted mortgages."

But he also found the way lenders priced mortgages meant borrowers on the standard variable rate (SVR) were paying as much as 2 percentage points more than a neighbour on the best short-term deal.

This meant that someone borrowing £100,000 at a 25-year rate of 5.73 per cent would pay over £100 a month more than someone on a discount rate of 3.84 per cent.

Professor Miles also found many cut-price deals were sold at a loss to the lender, which it recouped by charging far more to its variable rate customers than it was paying for the money - a margin as high as 1.8 percentage points.

Most short-term deals revert to the SVR once the cut-period lapses unless the borrower remortgages for the latest deal. Professor Miles admitted this meant there was a subsidy between "the stupid and astute".

While he declined to calculate the subsidy, he said more than 5.2 billion mortgages worth £244bn were being paid back on a variable rate. Assuming the lenders were making a 1.8 per cent profit on all those loans, this would amount to a cross-subsidy of almost £4.4bn. Professor Miles said borrowers had a poor understanding of the risks involved in taking out a short-term deal on a mortgage that was a lifetime commitment.

One lender, Cheshire building society, offers a 25-year fixed-rate mortgage, but only 500 people have taken up its 5.48 per cent deal since it was launched in September 2002.

Michael Coogan of the Council of Mortgage Lenders, said: "The important thing is to make sure that the mortgage market can continue to provide a spectrum of choices to fit individual consumers' needs."

David Bitner, the head of product operations at the MarketPlace at Bradford & Bingley said it would take a "big shift in psychology" to change the state of the market. "Consumers are used to hunting around for the cheapest products in most aspects of their lives," he said. "It is difficult to see why borrowers would want to switch to a higher-priced product."