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As recent reports from institutions including the Resolution Foundation, the Bank of England and the Institute for Fiscal Studies have shown, mortgagors are facing a significant shock as their ultra-low fixed-term mortgage deals secured over recent years expire and they face higher monthly repayments after refinancing. This is particularly acute for those who are already stretched in terms of their borrowing relative to their income.
This issue is less relevant in other advanced economies, where long-term fixed-rate mortgages are more common. With no need to refinance if mortgage rates are fixed to term, there is no risk of borrowers facing a shock when rates increase.
The UK is unusual in not having long-term fixed-rate mortgages
Source: European Mortgage Federation
Yet in the UK, there are few such products available. Why is this, given the clear advantages to consumers in reducing the risk of repayments becoming unaffordable at the point of refinancing?
A 2022 TBI report, Bringing It Home: Raising Home Ownership by Reforming Mortgage Finance, investigated the barriers to the provision of long-term fixed-rate mortgages in the UK and found obstacles to greater availability on both the demand and the supply sides:
The Current Landscape and What Needs to Change
The current mortgage market model in the UK, based on mortgagors regularly refinancing two- or five-year fixed-rate deals, suits both the major mortgage lenders (banks and building societies who use short-term funding to finance mortgages) and mortgage brokers, who receive regular repeat custom each time mortgagors have to refinance. Neither are keen on the idea of mortgages that are fixed to term, and current regulations around mortgage advice do little to encourage brokers to recommend longer-term fixes. Reforms that should be made to these regulations include:
Extending regulations against excess “churning” of investments – that is, recommending frequent product changes that are not in the client’s best interest, even if each individual transaction is reasonable.
Clarifying that recommending a long-term fixed-rate mortgage would not be viewed as mis-selling, even if mortgage rates subsequently reduce, as long as the risk is explained to the customer.
Removing the rule that mortgage advisors should not give advice on whether a client should rent or buy. Mortgage advisors should be able to recommend that a client takes out a long-term fixed-rate mortgage if that is the only way they are able to get on the housing ladder.
Help for First-Time Buyers
A key group of consumers who would benefit from long-term fixed-rate mortgages are first-time buyers who wish to borrow a larger multiple of their income. To obtain a mortgage, a prospective borrower must pass a stress test to demonstrate that they can not only afford the initial repayments but would also be able to cope if interest rates were to increase in the future. This test does not apply to long-term fixed-rate mortgages, so first-time buyers would be able to borrow more if those products were made available to them. However, the Bank of England also imposes a limit on the number of mortgages that providers can issue at more than 4.5 times a borrower’s income. Applying a restriction based on loan-to-income levels does not make sense for long-term fixed-rate mortgages, as the only consideration should be whether the fixed monthly repayment is affordable. Long-term fixed-rate mortgages should therefore be excluded from the loan-to-income flow limit.
Open Up the Market to Insurers
Banks and building societies are the main mortgage lenders in the UK, but they are not well placed to provide long-term fixed-rate mortgages as they are reliant on short-term deposit funding. In other advanced economies, life insurers are a key source of funding for long-term fixed-rate mortgages, but in the UK, Solvency II regulations make it unattractive for life insurers to hold these assets.
Changing the matching adjustment (MA) to Solvency II regulations would allow life insurers’ capital requirements to be calculated in an attractive way, were the duration of assets to match those of liabilities. However, the risk that borrowers will repay their mortgage earlier than planned would upset the otherwise close maturity of assets and liabilities, making the life insurer ineligible for lower capital requirements under the MA. Changes to the Solvency II regulations could allow assets with prepayment risk to be eligible for the MA if capital is provided to insure against the prepayment risk.
Even without these constraints, consumers would still have to make the choice to opt for long-term fixed-rate mortgages if they were more widely available. In the past, the view from the industry has been that British consumers were not interested in long-term fixed rates, preferring instead to go for the lowest initial rate and then refinance when necessary. Indeed, this has been the optimal strategy over the past 30 years when interest rates have trended downwards. But with slow wage growth and interest rates now on the rise, this is the time to increase the availability of long-term fixed-rate mortgages.
In the short term, we will no doubt see further attempts from politicians to encourage or even mandate forbearance from banks for those who are struggling with mortgage repayments. Extending support for mortgage interest through the benefit system is another option that politicians may turn to as more mortgagors feel the pinch. But in the longer term, we need to reform Britain’s mortgage market to reduce interest-rate risk for homeowners and, in so doing, boost home ownership.