Consumers
What factors affect my mortgage rate?
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How are mortgages funded?
The key source of funding of mortgage finance for building societies is the money deposited by their savers (The retail markets). Building societies are bound by law to source at least 50% of their mortgage funds from this source. In practice this accounts for around 70% of the funding in the building society sector. Funding can also be raised from the money markets (Wholesale markets). This is often money that is borrowed from other financial institutions for a fixed period of time.
Some building societies use only the retail markets and some use a mixture of retail and wholesale.
What factors contribute to the price of a mortgage?
The Bank of England Bank Rate alone does not determine mortgage rates, and building societies have many other factors to consider when pricing mortgages. Societies are also very careful to balance the needs of their savers with needs of their borrowers; savers outnumber borrowers 8 to 1.
Cost of retail funding (Savings)
The cost of attracting savings is expensive for a number of reasons and this affects the cost of mortgages.
• The Financial Services Authority is encouraging all institutions – banks and building societies – to increase the proportion of funding that they obtain from the retail markets. This competition is forcing savings rates sharply upwards and many institutions compete for savings. This is made all the more challenging as individuals are saving less than they did a couple of years ago.
• The scarce availability of funds in the wholesale markets has also meant increased competition for funds in the retail markets.
• To add to this, those banks that are supported by the State are able to compete unfairly for retail deposits. Steps need to be taken to ensure that Government backing for some institutions does not distort competition for savings.
• The current low interest rate environment, higher unemployment and low earnings growth makes if difficult for all savings providers to attract funds.
Building societies raise the majority of their mortgage funding from the retail markets and not from the Bank of England. Financial institutions only borrow from the Bank of England in certain circumstances, and this is at a premium well above the Bank Rate. For this reason, the interest paid on retail savings accounts far better reflects the cost of funding to a lender, and this is typically much higher than the Bank Rate.
Financial Services Compensation Scheme levies to cover failed banks
• Building societies are taking a disproportionate hit from the bailout of Bradford and Bingley, the Icelandic banks and London Scottish Bank.
• Societies have provided about £280 million for two years' worth of FSCS levies, and in year three the levy for the sector could be anything up to about £200 million. However, in subsequent years the cap on FSCS management expense levies may not apply, in which case the levies could be open-ended.
LIBOR
• LIBOR is the London Interbank Offered Rate, and is a benchmark used widely for short term interest rates on unsecured cash. It is often used to describe the rates that banks borrow from each other. As is the case for the Bank Rate, many smaller, unrated institutions that borrow from banks are charged a premium above LIBOR. Therefore, as with the Bank Rate, LIBOR does not provide a reliable comparator to the cost of raising funds.
The need to cover costs of higher liquidity holdings
• Building societies and banks have to hold a high proportion of their assets in high quality, low yielding liquidity. They make a loss on this because of the high rate they have to pay to raise their money in the retail markets which has to be recovered through mortgage pricing.
Swap rates
• Fixed rate loans are typically funded in the swap markets. This is where lenders use interest rate swaps to insure against changes in interest rates. Otherwise, if interest rates rose and lenders were charging fixed rates on their mortgages, they could make a loss. Swap rates depend in part on the rates of interest that money markets expect in the future, rather than moving in line with the current Bank Rate.
Exceptional circumstances
Bank base rate of 0.5% is the lowest interest rate that the UK has seen in over 300 years. It is impacting building societies’ ability to attract and retain depositors. It is difficult for building societies to compete with government backed banks for retail funding when they enjoy an explicit or implied guarantee of 100% and building societies are bound by the £85,000 FSCS limit. It is therefore necessary to sometimes make adjustments to SVRs in order to maintain their balance sheets.
All these factors can affect the cost of your mortgage.
