UK mortgages: financial innovation run amok. Source: Google images.
In a never-ending saga, I’ve spent quite a lot of free time these past few weeks studying the UK mortgage market. In sum: crazy:
- Where I’m coming from: US mortgages. In particular, the fixed-rate 30-year mortgage guaranteed by Fannie Mae or Freddie Mac. When my wife and I bought a house in the US, the choices were pretty much either a 15-year or 30-year fixed rate mortgage. Simples.
- How about a 30-year fix in the UK? Nope, not available. If only Americans fully appreciated how sweet the government support of housing is in the US. No dice in the UK. BTW, for those wondering – mortgage interest is tax-deductible in the US, but not in the UK. But anyway.
- What do Britons do? Fix for 2 years. The standard mortgage here seems to be a 2-year fixed rate, which then reverts to a penal ‘Standard Variable Rate (SVR)’ charged by the bank. Given low rates, there are several offerings for 3-, 5- and 10-year fixes these days. In practice, the assumption is the mortgager refinances by the end of the fixed rate period – spending another £1,000 or so on fees for the privilege of keeping a discounted fixed rate. Or they move, or pay off the debt, or…
- How to take advantage of low rates? Variable/tracker mortgages. If you believe rates will continue to fall, there are mortgages which either reflect changes in that SVR (‘variable’) or changes in the Bank of England base rate (‘tracker’). Those smart cookies who successfully predicted the massive fall in BoE base rates entered a strange world of negative mortgage payments in 2008/9. With the base rate at 50bps, I’m guessing there isn’t much further to go.
- Extension: but what if I wanted to ‘fix’ my own 30-year mortgage? The SVR is completely at the discretion of the mortgagee – they can change at will, so very hard to hedge interest rate risk on a variable, or indeed 2-year fixed, mortgage. The tracker is more interesting – BoE interest rate decisions generally take place at meetings announced well in advance, so could in theory be hedged. I’m looking into solutions involving Short Sterling and/or UK gilt futures to achieve the fix.
- Brilliant UK innovation – offset mortgages. It’s well-known that paying off mortgage principal early is a good thing, to build equity and lower total interest paid. But what if you come across a load of cash (a bonus, perhaps), with a potential need for said cash in the future (early retirement, perhaps)? The offset mortgage allows your cash savings to offset the mortgage principal; you can still access your cash if needed, but otherwise you only pay interest on the net amount of principal outstanding. I like that feature, though it comes at the cost of higher interest expense.
- But wait – don’t you loathe the UK housing market? Hmm… yes, particularly in London area. Upon further research, housing in the Midlands and North of England (+ Scotland and N Ireland) isn’t as overpriced/undersupplied as the dreaded Southeast. This is reflected in gross rental yields: London yields are a joke (3% p.a. before fees/fixes? Happy to rent with that.), while yields elsewhere are much more reasonable. So maybe worth investigating a purchase further afield.
What fun, investigating financial products. Ah, to have a 3.8%, 30-year fixed mortgage with a tax credit to boot instead.
financialpiggy 
Hi Matt,
There have been at times longer fixes. So in our last house (bought in 2006) we had a 25 year fix. However they were always very rare, and never especially competitive.
I spent part of the early 2000’s doing amongst other things the hedging of Barclays fixed rate mortgage book. To get geeky the issue is where the repayment risk sits. Does it sit with the bank, with the buyer (priced with a repayment penalty), or to buyers of a mortgage backed security (MBS)?
The US MBS market has always been much more developed than ours. Also, crucially, we never had a fannie mae or freddie mac – just private sector. After ’08 the private sector MBS issuance dried up, leaving almost nothing in the UK, whilst the public agencies in the US could carry on.
This also means that UK banks have traditionally lacked the expertise to warehouse repayment risk. Long dated sterling options markets are also less liquid than the euro and dollar equivalents.
UK buyers are uncomfortable with large repayment penalties; the very large penalties you’d need for a break after one year in a 30 year mortgage might not even stand up in court.
There is also the problem of history and culture; in a long period of falling rates it has never paid to fix for long periods. Persuading people they should do so now at the nadir of rates isn’t easy. You and I know that a series of 2 year fixes, interspersed with remortgaging charges, is an expensive way to access what is effectively floating rate funding. However the general public, reading newspaper ‘money’ sections, stuffed full of implicit and explicit advertising by mortgage lenders and brokers, doesn’t realise that.
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Thanks Rob, for the perspective. Do you suppose my study of immunisation/fixing via short sterling and gilt futures might actually work? Main concern is the large £ duration in early days, requiring a large quantity of SS shorts to cover the risk.
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I think I must have missed a pdf attachment??
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