Seize the opportunity to offer longer fixed rate mortages and scrap ERCs.

21 October 2019

Simon NicklinManaging Director, UK Financial Institutions Origination and Solutions

Dominic JamesonDirector, Head of Structured Finance Derivatives Solutions

Low interest rates create an opportunity for lenders

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Low interest rates create an opportunity for lenders to launch longer-dated fixed rate mortgages and scrap Early Repayment Charges.

Historically low interest rates, a flat yield curve and sophisticated hedging solutions create the ideal conditions for British lenders to launch longer-dated fixed rate mortgages and encourage demand for such products by scrapping or reducing typically unpopular early repayment charges (ERCs).

Longer-dated mortgage prices have potential to compete with shorter dated loans in the current interest rate environment.

Post-crisis, longer-dated fixed rate mortgages have failed to compete with shorter dated products however the financials have since changed1.

Since the crisis, longer-dated fixed rate mortgages have been considerably more expensive than short-dated fixes, or even non-existent, but the current interest rate environment creates the opportunity for lenders to offer longer-dated loans more cheaply, closing the price gap to short-dated fixes.

Borrowers may welcome the opportunity to achieve long term certainty in their mortgage payments at historically low interest rates.

Overcome the last marketing hurdle by stripping out ERCs.

ERCs discourage borrowers from committing to a lender for an extended period of time as borrowers have the prospect of paying a potentially large break cost should their circumstances change – a concern which is exacerbated in the case of long-dated fixed rate mortgages.

In the US mortgage market, where lenders do not levy ERCs, 90% of homebuyers chose a 30-year fixed rate mortgage in 20162.  Whilst the US mortgage market does have a different funding model to the UK, this still highlights the potential borrower appetite for longer term fixed mortgages with the right product features.

ERCs also tend to be a source of friction with customers and can result in unsatisfactory customer experiences upon prepayment3.

All this makes a strong case for reducing or eliminating ERCs on longer-dated fixed rate mortgages and the good news for lenders is that innovative risk management tools now exist to help make this a reality.

Hedging interest rate risk and mitigating prepayment risk  

Financing and risk management tools, such as NatWest Markets’ MicroRates platform, now offer lenders the ability to fully hedge the interest rate and prepayment risks within a mortgage portfolio so that no extra costs are incurred at the time of prepayment, transforming this cost into a “known” cost for the lender which can be factored into the pricing of the mortgage product. 

This gives lenders the flexibility to eliminate ERCs completely or structure mortgages with innovative ERCs.  For instance, the team at NatWest Markets have helped one lender launch a 10 year fixed rate mortgage which only charges ERCs for the first 5 years, making the product more comparable to a traditionally more popular 5 year fixed rate mortgage.

So, is now a good time for lenders to launch longer-dated fixed rate mortgages?

We think there may not be a better time…

Contact the MicroRates team

Interest Rates
Early Redemption Charges
Mortgages
Payments
Market infrastructure & regulation


Footnotes

1 Comparing 10 year fixed rate mortgages to 2 year fixed rate mortgages between January 2009 and April 2019, using Bank of England 75% LTV household fixed rate mortgage data.

2 http://www.freddiemac.com/perspectives/sean_becketti/20170410_homebuyers_communities_fixed_mortgage.page

3 For example, between 1st August 2015 and 31st July 2016, the Financial-Ombudsman Service received 508 new cases regarding early repayment charges https://www.bridgingandcommercial.co.uk/article-desc-11069_ercs-spark-over-500-complaints

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