First Bank rate cut in seven years - so, what happens now?
Published: 4 August 2016 | Author: Bernard Clarke
Today’s decision to cut Bank rate by 25 basis points marks the first time in more than seven years that there has been a move in the official rate. So, what does it mean for borrowers?
The most important point to make is that what happens now will depend on the terms and conditions of the mortgage agreement between the lender and the borrower. Most customers with a tracker mortgage – the majority of which are linked to the Bank rate – will hear shortly from their lender of any change in the rate applying to their loan and what their new monthly mortgage payments will be in money terms. Our data shows that more than 1.5 million of the UK’s 9.3 million owner-occupier borrowers are on tracker rates.
More than 3.5 million of these borrowers have a fixed-rate mortgage, and most of these customers will see no change to the rate applying to their mortgage until their fixed period comes to an end. Their monthly payments will therefore be unaffected by today’s decision.
Standard variable rate borrowers
Lenders who have customers paying their standard variable rate - and there are more than 2.2 million of these - will make their own assessment in the coming days of how their businesses are affected by the Bank’s decision. Each will take into account a range of factors that determine their cost of funding, other business costs and margins. The extent to which these may be affected by a change in Bank rate may vary from one firm to another, and individual lenders will write to customers when they decide to adjust borrowing rates.
But what would happen to borrowing costs if today’s 25 basis point change in Bank rate was reflected in a change of the same magnitude in mortgage rates? Table 1 shows the effect of a notional quarter-point rate on 25-year and 30-year mortgages of varying sizes. The “before” rate is based on the Bank’s recently published outstanding variable mortgage rate.
Table 1: Monthly mortgage payments - before and after a 25-point rate cut
|25-year repayment mortgage||Interest-only mortgage|
The average outstanding mortgage at the end of March this year stood at £116,000, which would mean a saving of around £15 a month for a typical borrower if the average repayment rate of 2.86% is reduced by 25 basis points. Their monthly repayments would come down from around £542 to about £527.
In April this year, the average first-time buyer took out a mortgage of £129,950. If that loan had been taken out on a repayment basis over 25 years and the lender cut the rate by 25 basis points, the borrower’s payments would come down by around £17 to £595 a month. The average gross household income for first-time buyers stood at £39,650, meaning that repayments accounted for 18% of income.
The average new mortgage for all house purchases in April was a little higher, at £143,500. So, if the average rate for a repayment borrower on a 25-year term was cut by 25 basis points, payments would come down by around £19 to about £656 a month.
A historical perspective
Today’s decision brings to an end an unusually prolonged period of interest rate stability by modern standards. The last change in Bank rate was in March 2009, when it was cut from 1% to 0.5%. Since then, more than two million first-time buyers have entered the market, none of whom have ever seen their mortgage costs change because of a movement in official rates.
The last time Bank rate remained unchanged for such a long period was during the Second World Way and its immediate aftermath. In October 1937, Bank rate was set at 2%, and it remained at that level until November 1951, when it was raised to 2.5%.
Throughout much of the 1970s and 1980s, Bank rate was much higher than it is today, or than it was in the post-war period, and movements in the rate became much more volatile. Bank rate peaked at 17% in 1979 – a figure unimaginable to today’s first-time buyer. After Gordon Brown as chancellor put the Bank itself in charge of setting the rate in 1997, Bank rate gradually moved to a lower and more stable level. But between October 2008 and March 2009, the Bank moved aggressively cut the rate from 4.5% to 0.5 % in response to the financial crisis. And Bank rate has remained at that level until today, even though credit is now much more readily available and we have seen economic recovery.
It would be a mistake, however, to assume that borrowing rates have been unchanged in the seven years since Bank rate was cut to 0.5%. According to the Bank’s data, the average fixed rate on an outstanding mortgage has fallen by almost half, from 5.7% in March 2009 to 2.94% today. Over the same period, the average outstanding variable rate has edged up from 2.59% to 2.86%, while the average rate for all mortgages has declined from 3.83% to 2.9%.
What affects borrowing rates?
Those figures show clearly that Bank rate is far from the only determinant of borrowing costs, which can vary considerably over time depending on a range of factors and changing market conditions. So, while Bank rate has remained unchanged, mortgages have been re-priced since 2009 as funding conditions have improved, competition has increased and confidence has strengthened.
Clearly, Bank rate has an effect on market rates generally, including those applying to mortgages. But the relationship is not clear-cut or entirely predictable because Bank rate does not represent the actual costs faced by individual lenders in raising funds at any particular point. Instead, mortgage rates are affected by a wide range of influences, including:
- the individual lender’s own cost of borrowing funds;
- the cost of managing risks inherent in borrowing to lend;
- the level of risk associated with lending;
- the cost to the lender of holding the required amount of capital;
- how the mortgage product is designed; and
- the lender’s target of surplus and/or profit in advancing the loan.
The point about a change in Bank rate is that, unless there is a contractual link to the mortgage rate, it may not result in a like-for-like move in borrowing costs. Lenders now more routinely adjust their pricing to a range of evolving market conditions, as well as Bank rate. And they do this particularly when launching new products, which is happening all the time.
As we have pointed out before, it is difficult to unpick and calibrate all the many influences on mortgage rates. They are influenced by a wide range of factors – and Bank rate is only one of them, albeit a very important one.