Distorted Market in UK Mortgage Loan Interest Rates, presently at Historical Extremes
Are About to be Reverted
by Mitch, December 16th 2013
Loan rates (Mortgages, Car Loans, Loans for Businesses etc..) are priced off the Interest Rate returns placed on Government Issued Debt in the form of UK Gilts. This has historically been true since the advent of our present ‘Fiat Fractional Reserve Monetary System’ has been in place these last 43 Years, this is obviously as it should be. UK Debt is rated AAA and the most secure debt in the land. Banks have to compete for funding in the open market which is then lent out in the form of mortgages and loans at higher rates (spread income) to produce a positive return.
(Note : The rates are approximate averages only, but gives us an excellent guide to work from)
|Year||10 Year Maturity Gilt Yield||Typical Variable Rate Mortgage||Difference|
|1997||7.2 %||9 %||+ 1.8 %|
|1998||5.9 %||9.25 %||+ 3.35 %|
|1999||5.9 %||7.25 %||+ 1.35 %|
|2000||5.4 %||8.0 %||+ 2.6 %|
|2001||4.9 %||7.0 %||+ 2.1 %|
|2002||4.9 %||6.0 %||+ 1.1 %|
|2003||4.6 %||5.7 %||+ 1.1 %|
|2004||4.8 %||6.5 %||+ 1.7 %|
|2005||4.35 %||6.6 %||+ 2.25 %|
|2006||4.6 %||6.7 %||+ 2.1 %|
|2007||5.0 %||7.5 %||+ 2.5 %|
|2008||5.0 %||6.65 %||+ 1.65 %|
I have taken it to 2008 as this was the start of the crisis and some extraordinary moves by the Central Bank to artificially support the property market. The average difference between 10 Year Gilt Yield and Typical Variable rate mortgage of the data series (12 years) above was + 1.97%.
Well something strange happened to this relationship with the advent of the ‘Funding for Lending Scheme’ on the 13th July 2012. This scheme was extended to January of 2015.
The FLS is designed to incentivise banks and building societies to boost their lending to the UK real economy. It does this by providing funding to banks and building societies for an extended period, with both the price and quantity of funding provided linked to their lending performance. However the Bank of England recently announced that the Funding for Lending Scheme (FLS) – which allows lenders to borrow at rock-bottom rates in exchange for providing loans – would not apply to household lending from January next year (2014).
So lets have a look at how this scheme has affected this historical relationship (UK Govt. Debt against UK mortgage rates) over the last 18 months, since the scheme started…..
As you can see typical 2 year Fixed Rate mortgage has dropped from 3.75% down to 2.5%. A typical variable rate mortgage at the moment is 1.9%.
While the UK 10 Year Gilt Yield (below) has moved up from 1.4% to 2.9%. That is a present difference of minus 1.0 %. This absolutely unheard off !!
How on earth can you borrow money cheaper (mortgage on a house) than the UK Government can borrow money in the open market and is rated AAA ? Without further “Unprecedented artificial” funding from the Central Bank the simple answer is – you CANNOT !
If the Central bank goes ahead and turns of this funding in just 3 weeks from now, how will the banks continue to offer massively discounted artificial mortgage rates ?
If we take the present 10 Year Gilt of 2.88% and then normalise this to the mortgage lending market, variable rate mortgages will be closer to 4.85% (2.88 + 1.97). A typical 2 year fixed rate mortgage will be closer to 5.5%. That is more than a doubling of Interest Rates on Mortgages from today’s levels.
Or if the market simply adds just 1.1% on top of the Gilt Yield (as in 2002 & 2003), that would give you a Typical Variable Rate of 4% and a typical 2 year fixed rate deal of 4.5% to 4.8%. Again this is a near doubling of todays rates.
Another nail in the Greatest London Housing Bubble since the 2nd World War ?