You can see why the Chancellor would like everybody to have a US-style penalty-free long-term fixed-rate mortgage. If base rate increases, there is no impact on borrowers. But if base rate is reduced, borrowers could redeem and take advantage of extra spending power.
So why aren't these products the norm? The truth is consumers prefer what they have now – a cheaper, wider choice with more flexible options.
“Cheaper” is key. Structuring a long-term penalty-free fix so that it is attractive to funders requires a number of elements that would not be needed with a short-term deal backed by redemption penalties. These elements cost money, pushing up the customer rate – which is why long-term fixes are so expensive versus what new UK borrowers are used to paying.
Lenders would normally need to hedge the exposure by the use of derivatives. Also, with the main funding demand for this type of product remaining in the US, there would be the cost of a currency hedge into dollars. I know that EMFA feel they will be able to solve some of these structural difficulties, but having brought bonds worth £2.5bn to the capital markets this year, I can tell them that sterling demand for exposure to the UK mortgage market is relatively thin versus the appetite of US investors.
Once you cost in all the features that would enable you to offer such a one-way bet for the consumer, the price becomes much more expensive than the alternative of the popular two-year fix, or two-year discount – sometimes by as much as 2 per cent. The consumer is not interested at that price.
Some building societies have launched long-term fixes with “redemption windows” – periods which could be used to redeem penalty-free. The rate on these is around 5.99 per cent – 1 to 2 per cent above the equivalent two-year fix. It will be interesting to see if these products fare better than their predecessors.
We undertook some research in the summer, when interest rates were at their lowest. We researched a 4.99 per cent 25-year fix with redemption penalties, giving the option of adding 0.5 per cent to the fixed rate to make the product penalty-free. The response from intermediaries was overwhelming – “don't bother”.
We shared this research with Professor Miles when he asked to see us as part of the report he is preparing for the Chancellor. It will be interesting to see what emphasis there is in the report on contemporary consumer preference.
And there is more to this than price. Borrowers in the UK have more product choice than anywhere else in the world. They can have fixes followed by discounts, discounts followed by caps, caps followed by trackers, flexible fixed, offset variable – even rates linked to another country's currency or Interbank rate-setting mechanism. UK borrowers are used to this choice and the demands of the bland, highly structured long-term fix cannot be easily reconciled with current product flexibility.
It is difficult to see why borrowers would want to give up access to all those options unless the Government disincentivises choice in order to make long-term fixes more attractive – don't rule it out.
Perhaps the answer is better consumer education. If the industry can find a way of explaining to consumers, prior to their arrival at point of sale, the benefits and risks of fixed versus variable, the market could operate normally. As a result of good education, some consumers may well want to pay a premium for longer-term fixed-rate protection. But we will in those circumstances be attracting the demand, rather than effectively contracting it by forcing it on people.
In short, there is no structural reason why long-term fixed rates cannot be made available to UK borrowers in plentiful supply. The truth is that for the foreseeable future long-term fixes answer a question the consumer isn't asking.
Stephen Knight is executive chairman and UK country manager of GMAC-RFC