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Local Financial Adviser comments on the drop in interest rates

The following was written on Friday 7th November to inform clients of a local independent financial adviser but perhaps of interest to visitors to AboutMyArea

Below I address the situations for:

• if you have a mortgage;
• if you have Savings;
• if you have Investments including pension funds.

If you have a mortgage

Lenders need a spread of rate between what they pay to savers, and what they get from borrowers, and when rates are low, a spread of 1-2% just about creates enough cash to operate profitably. However, the lenders are trying to recoup recent losses, and so would wish the spread to be higher at the moment. The drop in base rate to 3% means some will resist dropping rates for new deals, so as to maintain the wide spread, as well as offering attractive terms to savers.

Over this weekend however, I envisage that those lenders that have their own funds, will try and steal a march on the competition, and launch mortgage products with rates of under 4%, probably 3.99%.

The main names that have this capacity are Nationwide, HSBC and Cheltenham & Gloucester (owned by Lloyds TSB). Initially, this will be just for loans that are low compared to property value, and probably with fairly hefty fees, but they will tempt those locked into higher fixed rates (say 6% or higher) to consider paying the existing lenders penalty, and jump to a lower rate.

This needs careful calculation but the viability can be assessed accurately. This also applies to those with 'Lifetime' or "equity release" mortgages. By the end of the week, other lenders will be forced to follow suit for fear of having no attractive proposition; for some of the small lenders however, this will be a relief, as their limited funds have been oversubscribed.

Of most significance however, is that for those with little equity, or first time buyers with little deposit, the big lenders will wake up on Monday morning and realise that they can now offer a loan at what is an affordable rate to a borrower, say, 5.99%, yet be lending at twice base rate and so have a tremendous profit potential to offset the risks.

If you are on a rate deal that has or is due to end, waiting a week or two will I am sure bring good news of reasonable deals, provided you avoid the ludicrous set up charges that many lenders conceal behind their headline grabbing rates. If your loan is fixed at a higher rate at the moment, get your figures together and carefully do the calculation.

Whilst I accept further rates cuts are possible, I do not believe they will be very soon, nor be significant to greatly affect the market; perhaps a 0.25% just to make the topic newsworthy, and remind potential borrowers that rates are low.

If you have Savings

The banks will try and reduce your savings rates by the full amount, but be pressured to offer attractive terms. Obviously if you have a fixed savings product, you are, as they say, laughing all the way to the bank or building society. The potential for a wide margin between base rate and the rate offered to borrowers does allow for savers to still find attractive deals, but again, a week or two is needed to establish the new normality.

If you have Investments

The stock markets are largely run by short-sighted sheep that need things very simply put. Things are now simple enough for them to return.

Oil prices are dropping meaning manufacturing and transport costs are lower.

Wider margins for the banks will increase profit.

Less strain on household budgets means spending will increase.

The new US President is now in place with a strong house of representatives for 4 years.

US Economy will incur higher taxation to deal with national borrowing, but hopefully this will be offset by strong export initiatives.

The investors will return and the markets will rise.

Those with monies invested via Gilts and corporate bonds will also see gains, as the yield rates on bonds and gilts from recent years, will be far higher than new issue items, thus driving up the capital value of these items, and so again, we can envisage growth.

It all seems like good news but....

Sentiment and confidence will be very fragile for a good while to come, and unless we are to get into a similar mess in the future, the banks need far closer regulation and supervision. All 'financial instruments' need to be subject to a truly independent vetting and licence procedure before being used. If this is done unilaterally, then the regulation needs to stipulate that instruments offered internationally must also undergo such vetting.

Final thoughts

In 1998 I attended a presentation by Kensington Mortgage Company in which it was explained how they could lend money to those who had been bankrupt, in arrears, had court judgements for bad debts, or difficulty proving income. I stated my opinion that this would just lead to a mortgage 'mis-selling' scandal similar to the pensions mis-selling. I thought the banks would come unstuck and be punished. I was wrong; they came unstuck and were bailed out.

In 1991, I met with Marsh Myerberg of Bear Stearns Bank of Wall Street New York, as she launched the first US style securitised loan facilities in the UK. In a group with others, after having the financial structure explained, I asked 2 questions.

"Like a photo copy of a photo copy, won't the underlying asset quality degrade with each securitisation?"

"There must be a limit to the funds available, you cannot keep getting new money to fund the next batch of loans, what happens then?"

The answers were lengthy and positive but not clear, until March of this year when Bear Sterns of New York went bust.

John C. Cartlidge
Independent Financial Planner
Tel: 0151 336 6610
Email

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