How the Funding for Lending scheme is forcing mortgage rates down

The Bank of England launched its Funding for Lending (FLS) scheme on August 1st as it attempt a new initiative to get banks lending and to kick-start the property market.

In recent weeks, four major banks have launched new four or five-year fixed rate mortgage deals at under three per cent. HSBC were the first and were followed by NatWest, Santander and Nationwide.

The historically low rate mortgage products have been launched in part as a result of the FLS. However, there has been some concern that these deals are only available to homeowners with at least 40 per cent equity and that there are as yet few new, better mortgage products available for first-time buyers and homeowners with low levels of equity.

So, how does it work, what are the best deals available for homeowners and will the banks launch more competitive deals for first-time buyers and homeowners with low equity?

Funding for Lending

The scheme works by allowing banks and other financial institutions to borrow money at below market rates as long as they then lend that money to individuals and businesses.

Banks can borrow up to five per cent of their lending stock at just 0.25 per cent for four years as long as they increase their lending. If they do they can then access more of the funds at the lower borrowing rate.

The scheme will be monitored closely and the Bank of England says that banks that do not lend more will be penalised and have to pay 1.5 per cent interest on future borrowing.

The best fixed rate mortgage deals

At the moment the best new deals are on medium to long-term fixed rate mortgage products and not all of the new deals are as a result of the FLS.

Ben Thompson, MD of Legal & General Mortgage Club notes that “HSBC, for example, have said all along that they’re not currently planning to take advantage of the scheme.”

However, most of the sub three per cent four or five-year deals are as a result of an expectation of lower funding costs and lower rates.

Ray Boulger of mortgage brokers John Charcoal said: “Swap rates and 3m Libor have both fallen by around a quarter of a percent since the Mansion House Banquet speeches from The Governor and The Chancellor and 3m Libor, currently 0.74%, is still falling.”

HSBC

This has encouraged the cheaper products. HSBC started the ball rolling in mid-July by announcing it was launching a five-year fixed rate deal at just 2.99 per cent for borrowers with a 40 per cent deposit. The product comes with a £1,499 fee.

Santander

Santander followed this with a similar deal and fee, but their product is only available to existing current account customers.

NatWest

NatWest followed next with a 2.95 rate for a five-year fixed rate deal for homeowners with a 40 per cent deposit. However, this product comes with an eye-watering fee of £2,495.

However, this could still represent an excellent deal, especially if you are borrowing in excess of £100,000.

Ray Boulger comments: “The arrangement fee is well above average at £2,495, obviously to subsidise the rate, but even so this still represents fantastic value for mortgages of at least £100,000.

“A fee of £2,450 will instinctively put some people off, but to put it in perspective a £2,495 fee on a 5 year fix is equivalent to the same annual amount over the deal period as a £999 fee on a 2 year fix. Furthermore, the rate on nearly all 2 year fixes and trackers (including NatWest’s) is higher than 2.95%!”

Nationwide

This week, Nationwide has launched an alternative by offering a slightly lower rate, 2.89 per cent, over four years which is only available to Flex account holders with a loan-to-value (LTV) ratio of 60 per cent.

An additional product to try to appeal to those with slightly less equity was announced before by Nationwide.

Ray Boulger explains Nationwide’s alternative that attempts to find a slightly different niche in the market.

“For those who don’t want to play this game an obvious alternative is to offer slightly higher rates at better LTVs. Nationwide is doing exactly this; it has the market leading 5 year fix up to 70% LTV at 3.39% with a fee of only £499 for purchases (£299 for FTBs) and £999 for remortgages.”

So, it is clear that there is excellent value in the four and five-year fixed rate mortgage market, but are the low wholesale borrowing costs and the FLS going to mean that the mortgage competition price war extends to shorter-term fixed rate deals, other mortgage products and deal for first-time buyers and borrowers with low levels of equity?

Hope for borrowers with less equity?

Ben Thompson from Legal & General believes it will take some time for the same level of competitiveness to filter down to other parts of the market.

“The trend that we are seeing where everyone is fighting for the lowest risk customers will continue for quite some time,” he said.

“Despite this, it’s our expectation that in the mid-term price competition will become so fierce that the low risk section of the market will become over-commoditised. This will lead to lenders seeking out borrowers who are higher risk, as there will be higher margins available to them in this segment.

“In time we expect that benefits will trickle down and be made available to first time buyers and those with a lower deposit.”

Ray Boulger thinks that the new sub three per cent deals for five-year fixed rate mortgages means that mortgage products for the next LTV band below 60 per cent are expensive, despite smaller fees.

He said: “The rate differentials for the higher LTVs are at least 1%, which is far higher than can possibly be justified by the small increase in the risk or regulatory capital requirements.

“For those needing higher LTVs there is merit in waiting until the market settles down, when I expect better value will be available.

Ben Thompson thinks that eventually borrowers with less equity will begin to see cheaper mortgage deals.

He said: “Reduced funding costs for the banks will help to reduce rates on all mortgage types eventually. However, for the moment, the fight will stay contained around medium to long term fixes.”

Ray Boulger believes the recent developments in the mortgage market show that unlike Project Merlin, the FLS is proving successful already.

Ray Boulger of leading independent mortgage adviser John Charcol comments on the lowest ever 5 year fixed rate mortgage in the UK.

“With the launch of these new rates it is already clear that, in stark contrast to Project Merlin, the Funding for Lending Scheme is very quickly proving effective as far as the mortgage market is concerned.

“Not only does the scheme offer most lenders cheap funding over a 5½ year period and an incentive to increase lending, but it was also a significant factor in the sharp drop in swap and Libor rates since it was announced on 14th June,” he said.