Page last updated at 10:23 GMT, Tuesday, 10 March 2009

Will savers and mortgage rates fall?

By Ian Pollock
Personal finance reporter, BBC News

Professor Mervyn King
More rate cuts are unlikely, the Governor said

Millions of savers are now suffering a nasty shock.

Their instant access accounts are paying them almost nothing - on average just 0.17%, according to the latest figures from the Bank of England.

Both saving and mortgage rates have fallen sharply as the Bank has slashed the cost of borrowing to try to slow down the country's plunge into recession.

Of course, some borrowers with interest-only mortgages are delighted by all this as their monthly repayments have been cut by a whopping 90%.

So, can saving and mortgage rates fall any further?

New territory

The Governor of the Bank of England himself, Professor Mervyn King, said he did not think there was much chance of official bank rate going any lower than the current 0.5%.

Savings rates are almost at a floor
Paul Broadhead, BSA

And the opinion among lenders and their trade organisations reflects that.

"Rates being paid cannot drop much further - and many will not pass on this latest reduction in full," says Paul Broadhead of the Building Societies Association (BSA).

"Savings rates are almost at a floor," he says.

The typical building society raises 70% of its mortgage funds from its savers.

The worry for building societies is that if saving rates did fall even further, this would choke off the flow of funds they need to keep on lending to home buyers.

"I think we are about at the floor - there is little scope for lenders to make discretionary cuts to mortgage rates," agrees Bernard Clarke of the Council of Mortgage Lenders (CML).

"We are in territory we haven't been in before," he adds.

Enforced cuts

Of course, some lenders have already passed on the latest 0.5% reduction in full to their borrowers with standard variable rates (SVRs).

Those are the likes of the Nationwide, Skipton and the Cheltenham & Gloucester, all of whose SVR deals have an explicit link with bank rate and have to fall, or rise, in step.

But the rest of the industry is unlikely to be so generous.

Lenders need to cover their costs, such as huge increases in the levy to the Financial Services Compensation Scheme, and need to rebuild their reserves.

They are under pressure from the authorities to make sure they are protected against bad debts and growing arrears.

"There is hardy any further room for manoeuvre," says the CML's Bernard Clarke.

Tale of two societies

Not all lenders are the same though.

Mike Heenan
Mike Heenan of the Stafford denies savers rates are derisory.

The cheapest SVR mortgage in the country is currently on offer at 3.69% from the one-branch Stafford Railway Building Society.

Mike Heenan, chief executive, says he does it by keeping things as uncomplicated as he possibly can.

"The reason we can do this is that we operate a very simple business. We have no fixed rate deals, everyone pays the SVR."

His society has no wholesale funding at the moment - the money lent in mortgages comes entirely from his savers' funds.

And there are no expensive upfront fees, complicated mortgage offers or early redemption penalties to juggle with.

Is he paying derisory savings rates to fund this?

"Absolutely not," he replies.

"Our ISA rate is 2.5% for balances above 10,000 and our instant accounts offer 0.25% for balances below 250 up to 2% on 100,000 or above.

"We are getting a lot of extra deposits as people view building societies as safer than banks," he points out.

Balancing act

Things are bit more complicated at the Stroud & Swindon, the UK's 15th biggest building society.

We are constantly balancing all these factors to maintain a margin of profitabilitye

David Hill, Stroud & Swindon

Its SVR, at 6.29%, is the highest in the country.

But chief executive David Hill explains that with a much larger mortgage range, just 10% of his customers are in fact paying off their home loans on his SVR.

"By no means are we taking advantage of our customers," he says.

"Many are doing very well on fixed or tracker mortgage deals or are getting good rates on their savings," he adds.

He explains that one factor putting a floor under savings and mortgage rates is the increased competition from banks.

Because they cannot borrow so freely from each other anymore, they are now competing much more vigorously for high-street customers with money to save.

And when it comes to meeting the requirement to have much more of his own society's money held as cash, he suffers there too.

"We are getting less than 1% on the cash we invest," he says.

"We are constantly balancing all these factors to maintain a margin of profitability."

What now?

After the February rate cut a third of lenders cut their SVRs, and even fewer may do so this time around.

There is scope for five-year fixed rates to go a bit lower, but not for two-year deals

Ray Boulger, John Charcol

Those who pass it on will be those who did not last time, suggests Ray Boulger of mortgage brokers John Charcol.

Tracker deals have been the most popular with new mortgage borrowers in the past year or two.

They now come with a much higher margin above bank rate than before.

Typically they are priced at 2.75% above bank rate for those people with a 40% deposit, or at 3% above bank rate for others with less money to put down.

So new tracker rates are currently priced around 3.5%.

But while these short term tracker rates are unlikely to fall, Mr Boulger thinks there is scope for longer term fixed rates to come down in price.

The reason for this is that the government's new policy of quantitative easing has brought down the yield on longer term government bonds.

This will make the funding for longer term mortgages, such as those for 10 years, cheaper.

"There is scope for five-year fixed rates to go a bit lower, but not for two-year deals," Ray Boulger says.

"The biggest impact will be on ten-year deals with some lenders now bringing them out," he adds.

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