Fancy a 4-decade punt on interest rates...?
HOW do you fancy the idea of fixing your mortgage for 40 years? asks John Stepek at MoneyWeek magazine.
That's the innovation one mortgage lender is now offering UK borrowers.
And while you might not like the idea, it does tell us something about where we are in the interest rate, inflation, and housing cycle...
Kensington Mortgages is launching a mortgage where you can fix your interest rate for anything from 11 years up to 40 years. The rate you get will depend on the equity in your home (or the deposit, if you're a new buyer) and the amount of time you borrow for.
For example, for a 60% loan-to-value (in other words, at least a 40% deposit) you could get a rate of 2.83% for 15 years or 2.9% for 30 years. For those with just a 5% deposit, a 30-year will cost you 3.77%.
That said, because the rate is fixed, says Kensington, it means you don't need to "stress test" the loan for rising rates, which means you should be able to borrow more.
The mortgage will be able to move with you, and 10% annual overpayments are allowed.
I'm not making any judgement on this as an individual product (I'd need to look at the small print more – for comparison you can get a 10-year fix for about 2% at the moment). But I am interested in the overall concept.
Why? In the UK, we're used to a mortgage market where you are forced to think about what might happen to interest rates when you're taking out a loan.
I remember we had one memorable guest post in Money Morning years and years ago from a writer who compared the UK mortgage market to spreadbetting on interest rates. Which is sort-of true.
When you take out a mortgage with a variable interest rate, you are technically taking out a huge leveraged bet on the direction of rates, and one with actually pretty hideous consequences if you get it wrong. (The only real difference is that you almost certainly won't get margin-called, which does reduce the risk though only a bit).
If rates go down, your mortgage goes down too, and you're a winner. If rates go up, your mortgage costs go up, and you lose out. If rates go up enough, you might even end up losing the house. Of course, because you're taking all the rate risk, you'll also tend to find (though it's not always the case) that the floating rate mortgage is the cheapest one at the point of sale.
As the interest rate gets fixed for longer periods of time, the cost of the loan goes up (eg the interest rate on a 5-year fix will be higher than that on a 2-year fix). That's because the longer you fix, the more the rate risk gets pushed on to the lender.
Even with fixed loans though, you have a very real risk in the form of "refinancing" risk. Say you took out a five-year fixed-rate mortgage three years ago. You still have two years to go on that loan. The rate is nice and cheap – perhaps not as cheap as some you could've got, but still sitting below 2%, say.
However, you might now have a niggling thought at the back of your head: where are rates going to be in two years' time?
Inflation is rising strongly and the Bank of England keeps hinting that rate hikes might be coming (or might not be – governor Andrew Bailey is feeling awfully defensive about that right now).
So you might be worried that when you come to refinance, you won't be able to "roll over" the loan on the same terms. You might even be looking at your current fix and wondering if you should pay whatever penalty you might need to, in order to get out of it and fix for a longer term.
(To be clear, I have no strong views on this particular question in case you're wondering. I think inflation will go up while rates will be largely held down, but working out exactly what that means for mortgage rates specifically over the next two years is crystal ball stuff).
From this point of view, having the option of fixing the rate for the entirety of your mortgage period is no bad thing.
When a home buyer is the one bearing the interest rate risk, the worst-case scenario outcome is that you'll lose your house. In terms of life events that don't involve death, that's disastrous.
A lender should be much better-placed both to gauge and to manage interest-rate risk. So from that point of view, this is a welcome innovation. It's also one that might help to make the housing market somewhat less pro-cyclical (by which I mean, prone to boom and bust), though that's never entirely possible to take off the table in any market.
There's also a group of people – pension funds – who need to match liabilities. They are looking for fixed-income instruments (loans) which will give them a guaranteed (or near-guaranteed) income to match up the amount they need to pay out to pensioners in the future. So that means there should be a ready supply of funds to the companies providing these long-term mortgages.
What's interesting here is the timing.
You have 40-year fixes launching just as the market appears to be turning and rates look set to rise. On the one hand, that provides a canny lender with the opportunity to turn a nice profit (the early years of these loans are going to be really quite profitable at current rates). On the other hand, locking in that rate might turn out to be quite the punt on the future direction of both rates and inflation.
There's also the fact that there's the demand for these loans in the first place. Arguably, if you have to take out a 40-year mortgage to be able to afford to buy a house, then that shows that something has gone badly wrong with your housing market.
We knew that already. But there are certainly elements of this that smack of the sort of product that gets launched near the top of a market. Let's keep a close eye out for what happens next.