‘No Deposit’ Mortgages are Not Necessarily Low Cost to Borrowers or Society

The Centre for Policy Studies has a paper out arguing for low deposit, fixed-rate, long-term mortgages. The “no deposit” aspect of the headline reports triggered a bit of concern among those of us old enough to remember that the 2008 global financial crisis was triggered by defaulting sub-prime mortgages in the US housing market. Prima facie it sounded insane to go down this path…

The CPS’s chief wonk, Robert Colvile, has put out a lengthy rebuttal this morning which he summarises as

“This policy is designed to make mortgages accessible to those who can afford mortgages but not deposits – or at least not the current sky-high deposits.”

Mortgages are usually for terms of 25 years to pay off the borrowing over the borrower’s working life. A hangover from when working lives were only 25 years or so. 25 year fixed-rate mortgages in an era of ultra low rates sound like a great idea, giving certainty to borrowers over the lifetime of the mortgage. Guido and the CPS are at one on this, they could be welcome innovation in the mortgage market.

There are a few snags, a quick Google search has not turned up any 25 year fixed-rate mortgages being offered by mainstream high street lenders, yet. What will it take to encourage them? Well judging by the 15 year fixed-rate mortgage offered by Virgin – fat profits. With base rates at 0.1%, Virgin want 3.0% for their 15 year fixed-rate mortgage.* What does this cost borrowers?

Over the term of their loan, assuming not unreasonably that lenders like Virgin would look to maintain a 200 basis point spread on their financing costs, the borrower of £250,000 would risk having to repay £125,000 more than a floating rate borrower, if rates were to remain static for the term. There is no such thing as a free lunch, the fixed rate certainty generally comes at a higher cost to borrowers. If you can’t raise a deposit, the total cost of borrowing inevitably will be higher, a lot higher.

The fat interest rate margin Virgin are demanding might be driven down by more competition, though wholesale lenders might in turn be wary of backing loans to institutions lending on thin margins to consumers who can’t raise a deposit. A property downturn, say because rates rise precisely as feared, might see borrowers in negative equity sending their keys back to lenders. Paradoxically making fixed rate mortgages with little deposit cushion much more risky for lenders.

Rates could rise quite dramatically over the next 25 years, given that central bankers are thinking about inflation more kindly of late. That is why deposits give banks a margin of safety, given politicians will support banks with bailouts, those deposits also give wider society protection. Making mortgages deposit free for a few could be quite expensive for the rest of us in a housing downturn.

The irony of our situation is that quantitative easing and the ultra low interest rate policies that fixed the banking crisis caused by the housing loan crisis, have subsequently caused a housing price inflation crisis. The Bank of England now believes that the increase in house prices is now almost entirely due to low interest rates. Be careful of clever financial fixes…

*The current risk free 15 year gilt yield is 0.5%.
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mdi-account-multiple-outline Robert Colvile
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