Should borrowers be considering longer term fixes? Private Finance researches the options.

The price of long-term mortgage security is at its lowest point since the 2008 financial crisis.

* Fixing for ten years rather than two cost borrowers just 1.04% more in April 2018 according to average product rates – the lowest ‘security premium’ since the 2008 crisis

* Ten-year fixes still close to record lows while two-year pricing has risen from 1.35% to 1.72% over the last year

* Narrowing price gap cuts the difference in monthly repayments between ten- and two-year fixes from £105 to £77 – giving immunity from potential rate rises until 2028

* With households moving less often and rates having little room to fall much lower, borrowers may reassess their resistance to long-term fixes

It shows the average ten-year fixed rated mortgage at 75% loan to value (LTV) was 2.76% in April 2018, down from 2.78% a year earlier. In contrast, the average two-year 75% LTV fixed rate was 1.72%, up by 37 basis points (bps) from the record low of 1.35% seen in April 2017.

As a result, the ‘security premium’ or price difference between the average ten-year and two-year fixed rate mortgage has fallen from 1.43% last April to just 1.04%: the lowest it has been since December 2008, according to Bank of England data.

Back then, the average ten-year rate was 5.72%, whereas today’s average product is less than half of this price (2.76%) and still close to the record low of 2.66% seen in December 2017 and January 2018. Product availability has also improved, with ten-year fixes having been largely absent from the market between summer 2009 and summer 2014.

Graph 1: Price gap between ten- and two-year fixed rate mortgages at a ten-year low

Source: Private Finance analysis of Bank of England data

The narrowing price gap between ten- and two-year fixed rates has cut the difference in monthly repayments by 27% from £105 a month to £77 a month.

Based on a mortgage of £150,000, the average borrower would have paid £694 a month for a ten-year fixed rate product in April 2017, compared to £589 for an average two-year fix.

The rising cost of two-year fixes mean that monthly repayments would now be £616 for a £150,000 loan taken out at the last average rate, while the average monthly repayment on a ten-year product has remained stable at £693.

Table 1: Monthly capital and interest repayments for a £150,000 loan over 25 years

This falling security premium means that a small number of modest base rate rises over the next few years, coupled with a round of remortgaging costs if borrowers take a shorter-term fix, might be all that is needed for the 10-year rate to end up costing less.

Having restored the base rate to 0.5% in November 2017 after 15 months at an all-time low of 0.25%, the Bank of England has hinted that further rate rises may be on the cards this year. The next monthly decision from the Monetary Policy Committee (MPC) is due on 22 June, with the previous vote on 10 May having seen a 7-2 decision in favour of maintaining the 0.5% rate.

The higher cost of a ten-year fixed product comes with effective immunity against future rate rises, which benefits borrowers if rates subsequently rise but penalises them if rates subsequently fall.

Comparing historic interest rate trends over the last 100 years, the last period of sustained low rates came in the pre- and post-war period from 1932-51, when the base rate remained at 2%, before fluctuating between 2.5% and 7% in the subsequent ten years.

More recently, after falling from 14.79% in September 1990 to a low of 5.13% in February 1994 during the early 1990s recession, the base rate then fluctuated between 3.5% and 7.5% over the following decade.

Graph 2: Bank of England base rate trends – 1918-2018

Source: Bank of England 

While most ten-year mortgages are ‘portable’ and can be transferred to a new property when people move home, concerns over potential early repayment charges (ERC) if people want to reduce the loan (e.g. by downsizing), remortgage early or pay off the loan before the fixed period expires might have lessened the appeal of long term fixes in the past.

However, recent analysis by Savills suggested that the average family is now moving house just 1.8 times, compared to 3.6 times before the financial crisis, which may ease downsizing concerns.

Shaun Church, Director of Private Finance, comments:

“With small but more frequent rate rises rumoured to be on the horizon, borrowers should be cautious about growing comfortable or complacent about today’s mortgage pricing, which remains nearer to record lows for long-term loans than for short-term ones. Brexit is clearly a source of uncertainty, but the bargain-basement base rate for borrowers that we’ve come to accept as the ‘new normal’ post-2008 still seems unlikely to stick around indefinitely.

“The UK mortgage market has tended to favour a short-term fix, but longer-term options are looking increasingly attractive in anticipation of the Bank of England following through with incremental rises to the base rate. Locking in for a decade can give borrowers immunity from further rate rises hitting their monthly repayments, and allow them to benefit from today’s low pricing for up to a decade.

“In the past, the appeal of long-term fixes has been tempered by a perceived lack of flexibility and the chance that rates might fall and leave people paying more than they were switching every two years. However, with households staying put in their homes for longer and rates having little room to fall any lower than they already are, it may be time to reassess some of these concerns.”

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