The US and UK mortgage markets are well-developed but vary significantly. For example, US mortgage funding in 2021 hit $4.4 trillion, while UK mortgage funding was just over £315 billion. So even though both markets are incredibly liquid, they each have different characteristics.
Full-term fixed-rate mortgages are more prevalent in the US, while the UK mortgage market is based on relatively short fixed terms, usually up to 5 years. This prompts the question, why are US-style long-term fixed-rate mortgages less common in the UK?
Is the US approach to mortgages unique?
The first thing to recognise is that the US is the only country in the world where the 30-year fixed-rate residential mortgage dominates the market. Most countries, including the UK, focus on 25 to 30-year mortgages with a much shorter fixed rate term. There are two principal reasons why US homeowners have taken this approach.
US government policy
When you buy a 30-year mortgage with a permanently fixed rate, you give homeowners a degree of stability, as well as the underlying housing market and economy. Consequently, US governments actively encourage homeowners to choose this more stable long-term arrangement.
Securitisation of US mortgages
Fannie Mae and Freddie Mac are two bodies created by Congress to support the US mortgage market. These bodies buy and sell mortgage products and provide guarantees, ultimately creating massive liquidity for the US mortgage market. In addition, this has facilitated an enormous securitisation sector where individual mortgage interest and capital payments can be sliced, diced, and combined with other income streams to create resalable bonds.
The guarantees and securitisation of mortgage products require a standardised product: the 30-year fixed-rate mortgage.
US mortgage rates
Interestingly, while the 30-year US fixed-rate mortgage is most common, the mortgage interest rate is partly based upon the yield of 10-year US Treasury notes (and other factors). However, there is a method behind the madness. Data shows that the average US mortgage is either refinanced or will default within seven years. Consequently, using the yield on ten-year Treasury notes is more reflective of underlying market trends.
What is the UK approach to mortgages?
Historically, the typical duration of a UK mortgage has been 25 years. That said, in recent times, we have seen an increase in the term, which is now averaging closer to 30 years. We are also starting to see changes within the fixed-rate mortgage market, with homeowners moving towards the five-year fixed-rate period and beyond where possible. However, the UK market predominantly relies on short-term arrangements more than its US counterpart.
UK government policy
The UK government is highly supportive of the mortgage market, aware that this is critical to long-term economic growth. As a result, various financial support packages have been introduced, which have helped maintain stability during recent challenging times. While many of these schemes are initially relatively short-term, they are often extended or replaced by similar financial schemes.
Securitisation of UK mortgages
Similarly to the US market, securitisation of mortgage assets is commonplace in the UK, allowing lenders to adjust their risk profile and maximise liquidity. However, the presence of Fannie Mae and Freddie Mac has undoubtedly encouraged the growth of securitised products in the US, perhaps more so than in the UK. Will a mix of regulations and cultural leanings continue to see the UK mortgage market steer clear of whole-of-term fixed-rate mortgages?
UK mortgage rates
In the UK, fixed-rate mortgages revolve around two-year, three-year and five-year terms. The Treasury yield on similar-duration bonds will influence the rates for these fixed-rate terms. So, today’s interest rate on a new five-year fixed-rate mortgage would be linked to the yield on UK Treasury five-year notes (plus a premium to take in costs, risk and profit for the mortgage provider). Bank of England base rates and yields on ten-year UK Treasury bonds tend to influence the standard variable rate.
Are UK homeowners now more receptive to longer-term fixed-rate mortgages?
In a move which may surprise many people, a new digital mortgage company in the UK has announced plans to launch a 50-year fixed-rate mortgage. While this would certainly be a radical shift in the UK market, many might say it is overdue and will no doubt prompt an interesting discussion. This comes at a time when 35-year mortgages are now available in the general market, although, as yet, the majority are only fixed for a maximum of five years.
Pros and cons of a long-term fixed-rate mortgage
As we stand on the possible verge of a change in UK mortgage culture, it is essential to appreciate the pros and cons of these longer-dated instruments. Some of the benefits include:-
- Certainty of payments and more long-term visibility
- Lower monthly repayments over an extended period
- Affordability will be less of an issue
- Attractive for first-time buyers
It is also important to be aware of the potential issues with long-term fixed-rate mortgages, such as:-
- Overall cost, including interest, will be higher
- Less flexibility
- Unsuitable for older borrowers
- You may never own your home outright
The flexibility issue is crucial because you may be locked in for five years before you can switch without any penalties. Unfortunately, as competition is currently lacking in this area of the UK mortgage market, penalties for switching within five years could be relatively high.
Would long-term certainty help the UK economy?
In time, it would be no surprise if the UK government formally backed the use of long-term mortgage arrangements similar to the US. For example, due to historically low interest rates in recent years, over 1 million UK mortgages are due for refinancing in 2024. To put this into perspective, two years ago, UK base rates were 0.1%, and today the rate is 5.25%. As a result, many homeowners looking to refinance their mortgages will face monthly payments 2 to 3 times higher than their previous fixed rate.
This level of uncertainty does nothing to help the UK economy and will significantly reduce disposable income. Moreover, coming at a time when the UK is facing a cost of living crisis, many homeowners may be forced to make alternative plans.
Summary
The US government promotes long-term fixed-rate mortgages, with Fannie Mae and Freddie Mac maintaining liquidity in the mortgage market. However, there have been difficulties. The US subprime mortgage crash of 2007 is a perfect example of an overheating market, still awash with liquidity and ultra-competitive. This saw mortgage brokers prepared to take on more significant risks in search of higher returns, which fed into the mortgage securitisation market and the subsequent collapse.
Slowly but surely, UK culture is moving from dependence on short-term fixed-rate mortgages to greater stability with longer-term arrangements. This may be challenging in the short term, with limited participants and liquidity issues leading to uncompetitive rates, but it is a start.
Whether you are a first-time buyer or looking to refinance your mortgage, please call us and we can discuss the options in more detail.