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Last Updated: Tuesday, 9 December, 2003, 12:28 GMT
Call for more long-term mortgages
Professor David Miles of Imperial College London was commissioned by the Chancellor to examine why long-term fixed rate mortgages are so unpopular. Read his report in full below.
Many UK home buyers are unaware of the benefits to be had from long-term fixed rate mortgages, according to a report commissioned by the Treasury.

Instead, they look for the lowest initial repayments, even if the cheap deals last for only a couple of years.

The study is the first of two which explore why Britain's property market appears stuck in a boom-and-bust cycle.

And it comes as speculation increases that the next slump could be upon us in months and prompt a recession.

Unpopular choice

UK Chancellor Gordon Brown, who will give his pre-Budget report to Parliament on Wednesday, is convinced that house price swings pose a major threat to the nation's economic well-being.

Earlier this year, he blamed house price volatility for "most of the stop-go problems that Britain has suffered in the last 50 years."

Tuesday's report by Professor David Miles of Imperial College London was commissioned by the chancellor to examine why long-term fixed rate mortgages are so unpopular in the UK.

Even though they are common in the US and continental Europe, they account for less than 5% of British home loans.

See how the UK housing market measures up

The 124-page report found that with the public receptive to discounted short-term products, the long-term fixed rate mortgages get crowded out of the market, appearing relatively expensive.

In reality, they are not overpriced nor do they necessarily represent a bad deal.

For example, Professor Miles found that the typical short-term fixed-rate mortgage was priced barely above the bank's own borrowing costs.

The cheapest was even priced at a loss.

In contrast, margins on the typical standard variable rate mortgage were much higher, at an average of 1.79 percentage points above the bank's borrowing cost.

As for long term fixed mortgages, many consumers seem unwilling to sacrifice a low initial rate of interest in return for guarantees that repayments will not increase regardless of rises in the Bank of England base rate.

"A great many borrowers focus on the initial cost of debt and do not seem to consider carefully how those payments might change relative to their incomes," the report notes in its conclusions.

And it warns that "many households seem to have a poor understanding of the risk characteristics of different financial products".

Hardly any long-term mortgages available

"Lenders have stuck their head above the parapet on a few occasions and offered long term fixed rates. However, borrowers have shown absolutely no interest in taking out 25-year fixed rate mortgages," David Bitner, technical director at Bradford and Bingley Marketplace said.

At present only the Cheshire Building Society and Leeds and Holbeck building Society are the only lenders to offer a 25-year fixed rate loan.

There is an element of cross subsidy in the marketplace but more consumers than ever are choosing to remortgage when they see the right deal
Council of Mortgage Lenders

Cheshire charges interest of 5.78% on the mortgage - higher than many lenders' standard variable rate - and only around 200 of its 60,000 borrowers have taken out the home loan.

Competitive market

The drawback to discounted products is that they have to be paid for by borrowers on a standard variable rate, on which margins are much higher.

In effect, Professor Miles said, the financially literate are cross-subsidised by those who choose not to, or cannot, shop around.

Many borrowers, he said, were unaware of just how much these subsidies cost them.

According to the report, any individual bank which removed upfront discounts would probably lose market share, hence there is no incentive for any mortgage provider to deviate from the dominant price structure in the market.

"Professor Miles has put his finger on a key issue - lenders are only responding to the market. There is an element of cross subsidy in the marketplace, but more consumers than ever are choosing to remortgage when they see the right deal," a Council of Mortgage Lenders spokesperson said.

Professor Miles's next step will be to talk to the Financial Services Authority and the Office of Fair Trading about which steps to be taken to improve the functioning of the market.

He was keen to point out, however, that the market was intensely competitive and there is no suggestion of the companies colluding to maintain the pricing environment.

Prior to the report there were suggestion that to make long-term products more attractive, the government could promise to bail out mortgage lenders if they get into difficulties. or provide tax incentives.

But either option would incur costs that would have to be met with taxpayers' money, and the government may prefer not to be seen to be subsidising homeowners.

Another difficulty is that countries such as the Netherlands and Spain, where fixed loans are the norm, have also experienced house price booms in recent years.

On Wednesday, the Treasury will publish Kate Barker's review of housing supply in the UK.

The BBC's Evan Davis
"Customers take the mortgage that looks cheaper for now, even if it may cost more later"

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