Mortgages Should Become Cheaper

Will falling house prices force lenders to be less greedy and accept lower margins on their mortgages? Cliff D'Arcy gives his views.

As part of our 2012 series, today I'm looking at how falling house prices may force lenders to be less greedy and accept lower margins on their mortgages.

If you download our free online guide, you'll see that in the first of his five financial predictions for 2012, wise old Fool Dr David Kuo expects the average house price to fall by a fifth (20%) this year, before returning to growth from 2009 onwards. This would cause the value of a typical UK home to fall by £13,000 over the next four years, and put an end to a twelve-year surge in house prices.

While many homeowners will regard falling house prices as bad news, cheaper housing helps first-time buyers and those who plan to move to large properties. However, after a dozen years of rising prices, property is now our biggest asset, so price falls have a major impact on our wealth and willingness to spend.

Then again, borrowers who are struggling with higher monthly mortgage repayments have two reasons to be cheerful. First, the Bank of England's base rate was cut by a quarter-point last month to 5.50% a year -- the first reduction in over two years. What's more, thanks to the worldwide credit crunch, more cuts are predicted for 2008, taking the base rate to 5% or less.

Second, I expect falling house prices to lead to a reversal of 'margin creep.' I wrote about this phenomenon in The Great British Mortgage Scam, when I proved that the Halifax had increased its interest margin on its standard variable rate (SVR) throughout the housing boom. In other words, the difference between the Bank of England's base rate and the Halifax's SVR had grown. Indeed, the UK's biggest mortgage lender today enjoys an interest margin of two percentage points over base rate, compared to one point during the early Nineties.

Of course, only a minority of mortgage borrowers pay their lender's full SVR, as most are on special-rate deals, such as fixed, discounted, capped or tracker rates. Nevertheless, millions of variable-rate mortgages are linked to lenders' SVRs, so these loans are less competitive than they were in the early Nineties. Hence, this partly explains the growing preference of homebuyers and movers for fixed-rate and base-rate tracker mortgages.

So, interest margins on variable-rate mortgages have increased dramatically since the Nineties. However, the evidence suggests that this trend will go into reverse once the housing slide really begins to bite. In fact, this is exactly what happened during the housing crash of the Nineties, when mortgage lenders cut their interest margins in order to keep monthly repayments affordable, reduce bad debts and avoid repossessions.

To sum up, I expect variable-rate mortgage deals to become more competitive as lenders cut each other's throats to maintain their share of a dwindling base of mortgage borrowers. On top of a falling base rate, this would be a welcome shot in the arm for hard-pressed homeowners!

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> This article first appeared in an email.