Most Homeowners Won't Get A Rate Cut

The Bank of England has cut its base rate by 0.25%. Alas, few borrowers stand to profit from this rate reduction!

At noon on Thursday, the Bank of England reduced its base rate by 0.25%, taking it from 5.75% to 5.50%. Of course, this is good news for people who pay a lot of interest, particularly those with big mortgages. Conversely, it is bad news for people who prefer earning interest to paying it, including myself and other savers.

However, despite some sighs of relief from mortgage and property firms, a single quarter-point rate cut won't breathe new life into the housing market. This is partly because only a minority of mortgage borrowers will benefit from this rate cut. Let's establish which mortgage borrowers will immediately benefit:

Almost all homeowners with tracker mortgages will see their interest rate cut from yesterday, although some may have to wait up to a month. (Once again, the transparency and flexibility of trackers shows why they are gaining in popularity.)

Two major lenders, the Halifax and Nationwide BS, cut their respective standard variable rates (SVRs) by the full 0.25% yesterday. Thus, new customers of these lenders will see lower variable and discounted rates immediately. Existing borrowers with variable rates linked to these SVRs will see their rates drop next month.

Nevertheless, most borrowers won't stand to profit from the first base-rate reduction since August 2005. Those who will gain nothing (or very little) include:

• Homeowners with fixed-rate mortgages, whose monthly repayments won't change until their fixed-rate deals end. Furthermore, today's fixed rates are far higher than they were two, three and five years ago, which could mean `payment shock' for many borrowers.
• Customers of lenders which decide not to pass on the rate cut. Given the ongoing credit and liquidity squeeze in the inter-bank lending market, it's quite likely that some lenders will seek to boost their cash flow by keeping their rates on hold.
• Some borrowers will receive only a token cut, because wide spreads between the base rate and LIBOR are making life tough for many mortgage lenders. Indeed, the gap between the base rate and three-month LIBOR was around 0.9% before this rate cut. Hence, the base rate may have to fall to below 5% for market rates to match the levels seen before the Northern Rock crisis.

Two more snags: higher margins and bigger fees

What's more, it's worth noting that standard variable rates (the rates paid by all mortgage borrowers who aren't on a special-rate deal) are considerably higher than they have been this century. For example, in April 2001, when the base rate was the same as today's 5.50%, Halifax's SVR was 6.50%. After yesterday's cut, Halifax now has an SVR of 7.50% -- a full percentage point higher than 6½ years ago!

Thus, homeowners with variable-rate loans now pay much higher margins than they did in the past. In addition, mortgage arrangement fees have almost doubled in the past two years, which allows sneaky mortgage lenders to promote lower headline rates. Unfortunately, a mortgage with an apparently low rate and a high fee can easily be more expensive than one with a higher rate and no fee.

So, Thursday's rate cut is only the first step on what will undoubtedly be a long, hard road to tackling the UK's addiction to credit. For borrowers to feel real relief, two or three more base-rate cuts will be required. However, this would weaken the pound and place upward pressure on inflation, which the Bank of England wants to avoid. Truly, the Bank is caught between a rock and a hard place -- and the foremost losers will be British businesses and consumers.

Finally, I've made my bearish views very clear in the past regarding the UK's reliance on ever-higher house prices and levels of personal debt. Indeed, I've been the Fool's doom-and-gloom merchant for the past five years -- at least until über-bear David Stevenson arrived! All the same, I've never been so gloomy about the prospects for the British public and the economy for at least fifteen years. So, please promise me that you won't go mad on credit this Christmas, will you?

My thanks go to Fool globalarbtrader for inspiring this article with his excellent post!