Unfix Your Advice?

Thu 23rd November 2017

Unfix Your Advice?

The recent report that one of the larger building societies has seen an upswing in demand for variable rate mortgages since the Bank of England raised base rate might at first seem counter-intuitive. However, I believe that there are good reasons behind this phenomenon.

The Prudential Regulatory Authority sets rules on how much lending can be undertaken by building societies on a fixed and variable basis.  Fixed and tracker rate products are classed as non-administered lending and we must adhere to maximum levels. In order to maintain the balance of lending types we also promote our discount variable rate products, sometimes quite enthusiastically!

To make variable rate lending sufficiently attractive, discounts will often be set as keenly as they can be, and will be designed to undercut comparable fixed rate products. In terms of our own product range, our cheapest variable rate is currently 0.41% cheaper than the cheapest comparable fixed rate, and other lenders have similar pricing strategies. To maximise fixed rate capacity, lenders may also decide to only provide variable rate products for lending in any areas of specialism that they cater for (where they have greater pricing power).

So, what about the client? If you are a broker, do you have a fixed mindset? In other words, do you generally recommend clients take a fixed rate? If you do, that’s hardly surprising; that’s what clients may indicate that they require during the mortgage interview.  For many borrowers, it will also be the right advice. I do however, believe that variable or discounted rates can sometimes be the more appropriate choice. Often on rate/cost grounds, but also because this can also provide access to specialist sectors, and to products with greater flexibility around Early Repayment Charges, or with lower fees.

Now that a base rate change has occurred, market sentiment suggests that the next change could be some way off. Perhaps more importantly, the Bank of England appears to agree. Mark Carney himself has said that any further increases will be ‘at a gradual pace, and to a limited extent’, with the expectation being that future increases will not take Base Rate much higher than at present, even into the medium term. Current talk is of perhaps only two further increases in the next couple of years, each of 0.25% (although of course things can change). There is also some talk of a potential reversal of the recent increase if choppy waters are encountered during the Brexit negotiations.

It is worth noting that before the recent increase, expectations existed of further increases in the relatively short term. Whilst the bank has now acted, the more dovish tone accompanying the increase has changed expectations. If a Bank Base Rate increase of 0.25% did occur then this would in many cases leave your client still paying less with a variable rate, and only after a second or maybe even a third similar increase would their monthly payment be higher.

The timing of any increase is as important as the magnitude. If the first increase occurred well into a product incentive period, then the borrower would have already had the benefit of the lower rate when their debt was at its highest. Rates would then need to rise rather more sharply to leave them worse off by the end of the incentive period than they would have been if rates had risen earlier on.

Where your client’s budget is under pressure, or they are risk-averse, I wouldn’t want to deter you from recommending a fixed rate product. However, I do believe that balanced advice will look at the rate differential between options, and also touch on the likelihood of various events occurring, and this could result in a broker-client discussion which covers the pros and cons of both approaches. Many applicants will undoubtedly still end up with a fixed rate product at the end of this process, but perhaps some others won’t, and for these, this could be a great outcome.

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