'Generation Buy': Are long-term fixed rates the answer?

That appears to be the case with the recent renewed focus on long-term fixed-rate mortgages, this time given new vigour by the Prime Minister, Boris Johnson, as part of his attempts to turn ‘Generation Rent’ into ‘Generation Buy’.

Johnson, in his recent Conservative Party Conference speech, suggested that the next big first-time buyer-focused scheme to be supported by the Government would involve Government-support to increase the number of high LTV mortgages available to those with smaller deposits, and it would be long-term fixed-rate mortgages that would be easing the path of these individuals on to the housing ladder.

As mentioned, the long-term fixed-rate mortgage debate has been going on for some time. It is normally accompanied by a focus on why the UK market steadfastly refuses to embrace these types of products when many countries in Europe, and indeed, around the entire world, have. It tends to argue that a greater move towards the use of longer-term fixes would provide greater certainty for both borrowers and the Government about the ability of borrowers to keep on affording their mortgage payments over the length of their entire mortgage term.

Interestingly, in the UK we tend to have to define what we mean as ‘long-term’ because generally we see five/seven/10-year mortgages as being within the definition, when actually long-term in most other countries is 20/25/30-year terms. Johnson has definitely been talking about the latter.

The arguments about why the UK is seemingly not a long-term fixed-rate market are well worn. Indeed, back in 2003/4 Professor David Miles issued a report on this very subject with three main reasons given – borrowers prefer low initial repayments, borrowers don’t understand how taking a longer-term product helps them mitigate against the risk of rates rising, and lender competition works to make these products unattractive, for example, better rates for new customers subsidised by higher rates/SVR, etc, for existing customers.

Now, there is a point to be made about the environment the report was published in. Back in March 2004 Bank Base Rate (BBR) was 4%, it would go up to 4.25% in June and end the year at 4.75%. After that it would climb fairly steadily over a three-year period peaking at 5.75% in July 2007.

While the correlation between BBR and mortgage rates can be rather flimsy, it’s safe to say that a first-timer taking out a 30-year product (with ERCs) back then would most likely have been ‘priced in’ at 5-7%. In other words, given what rates have done over the past 13 years – with BBR currently at 0.1% - I suspect they might have been kicking themselves after five or so years of having that product.

There are some assumptions here of course – the big one being that a long-term product would have long-term ERCs which would mean the borrower would have to pay considerably to leave the mortgage, although I suspect such a decision would have been the right one over the past decade. Many of the arguments made against these products focus on this point – Johnson’s new Scheme will have to find a solution here, albeit there is the advantage of current interest rate levels making the products potentially more attractive anyway.

The point is that in a high-rate environment, long-term fixes make even less sense, but there could be a much stronger argument for utilising long-term fixed-rate mortgages right now, especially if there could be a stronger connection between BBR and the rates that are offered to first-time buyers. That however is something of a big if – currently BBR as stated is 0.1%, if you’re a first-time buyer with only a 5% deposit now, and you can find a mortgage, you are much more likely to be paying 3%-plus.

Products will need to be competitively priced in order to make them attractive to first-time buyers, even if they are backed by Government and some borrowers believe they are the only show in town for them. That’s because there have been so many consumer financial services instances where being locked into long-term financial products has turned out to be incredibly costly, and there will be a fear factor that this could be the case here.

Plus, the better rates are on shorter terms, they allow for flexibility if circumstances change, and we’re constantly told to use advisers/shop around for our finances, especially when it’s likely to be the biggest monthly outgoing. One also suspects that the advisory market will take some convincing – for many reasons – especially if there are lots of other options available and, what we are seeing right now in terms of high LTV product choice, is more a temporary blip rather than a long-term trend.

Overall, we have a way already – in the form of private mortgage insurance – which can allow lenders to offer high LTV products and price them at competitive levels. They could offer 30-year mortgages doing this, but I suspect they will not wish to when the market leans heavily towards shorter-term products.

Long-term fixes may get some borrowers into homeownership with the Government adding its considerable weight behind them, and in a low-interest-rate environment they have a better chance than at perhaps any other time. I will however reserve judgment on whether we will see two million renters moving into the owner-occupier space, as I suspect the enthusiasm of Boris Johnson might not be matched by those offering, advising, or taking out the loans.