Plan for a safer and fairer future for borrowers

The findings of the Miles inquiry outline a future in which fairer and safer 10-year, fixed-rate loans will replace short-term discounts, but were swiftly condemned by critics who warned that it will drive up interest rates for first-time buyers.

The report's key recommendation is that lenders will be forced to offer the same deals to all borrowers, whether they are new or existing customers. New "what if" letters will alert borrowers to the risks of rising interest rates and how short-term deals can be dearer in the longer term, while annual statements will tell all borrowers of the lender's best deals and how they can switch to them.

None of the individual proposals are revolutionary, but its author believes that, when combined with new funding sources for banks and building societies, it will progressively tilt the UK market away from short-term deals into fixed-rate mortgages over eight to 10 years.

It falls short of the chancellor's dream of shifting Britain into US-style 25-year, fixed-rate mortgages but, if successful, will make Britain's homebuying market more akin to Germany's.

The report's author, Professor David Miles of Imperial College, said: "I did not see my brief as trying to bribe or force the great British public into taking 25-year, fixed-rate mortgages. But under these proposals I would expect to see the market have a significantly higher proportion of longer-term fixes."

In private, the big lenders welcomed a distinct change in "tone and content" of the final report compared to the interim report that he delivered in December, which suggested that an OFT investigation could be in the offing. One said: "The end result will be a narrowing of price differentials between new and existing customers and between shorter and longer-term fixes. But it is a leap of faith to think this will drive a large part of the market into long-term fixes."

Fairer pricing


British home buyers "focus excessively on the level of initial payment and insufficiently on the range of possible repayment costs some years ahead," said the report. Lenders unfairly subsidise loss-leader deals to lure in new borrowers, paid for by existing customers who are charged over the odds, said Prof Miles.

Presently 25% of mortgage lending in Britain is on fixed rates but the fixed periods rarely run for longer than two or three years. The proportion of borrowers fixing for more than five years has never been higher than a couple of per cent. Prof Miles recommends that the Financial Services Authority should require that "lenders make their full range of mortgage products available to all borrowers."

This is being widely interpreted as a move to squeeze loss-leader, short-term rates out of the market, thereby making long-term fixes more attractive.

Most new borrowers opt for two-year discount deals starting at around 3.7% ignoring 10-year and 25-year fixes which cost at least half as much again, typically 5.5%-6%.

But critics said yesterday that first-time buyers will lose out. David Bitner, of the Marketplace at Bradford & Bingley, said: "It would force many lenders to drive up rates because it would be too expensive for them to offer all borrowers the kind of competitive deals they offer to attract new customers."

However, Prof Miles said the short-term deals may be fooling borrowers. "What is it about these deals that is cheap? They may be cheaper to start with, but they switch to a higher rate later. To maintain a low payment upfront borrowers have to remortgage constantly, and it's not obvious that this is the best way forward. The sustainability of today's scale of remortgaging is questionable, and there's no guarantee that further down the line remortgage rates will be so attractive."

What If?


Lenders will be forced to tell borrowers about the painful impact of interest rate rises under proposals for "What If?" letters. These will outline the monthly cost of a mortgage under existing market expectations for rate rises plus a "surprise" scenario, which in Prof Miles's report sees rates rising as high as 8.5%. The purpose will be to dissuade borrowers from focusing too heavily on the initial, discounted cost of a loan and more on longer-term risks.

His example shows a £75,000 tracker mortgage which he admits is £1,390 a year cheaper than a 10-year fixed rate at current rates. But it becomes £845 more expensive if mortgage rates rise by 1% and £9,000 more if rates hit 8.5%.

He is concerned about the level of risk for first-time buyers; 60% of these in London and the south-east now have loans more than three times their income. Private polling also found that more than half of households will struggle if today's historically low interest rates rise by as little as 1% or 2%.

Consumer education


A new levy on the mortgage industry will pay for improved consumer education on borrowing, while advisers at banks and building societies will face stricter exams if the proposals go ahead.

To help consumers shop around, lenders will be told to include information about the FSA's "best buy" league tables available online at the regulator. The report also calls for the FSA to issue a short, user-friendly guide on remortgaging to aid borrowers.

The industry said the proposals could backfire. "The logical outcome of these proposals is that it will entrench remortgaging in and out of short-term deals, rather than shifting people into longer-term deals," said one lender.

Funding sources


Half of the report's recommendations focus on technical funding issues to promote a more liquid wholesale market to enable building societies in particular to offer longer-term fixes. One proposal is for the relaxation of rules on building societies which force them to obtain at least half of their funding for mortgages from savings deposits by customers. This would be reduced to 25% under the report's recommendations.