Mortgage lenders profit more from selling variable or short-term fixed mortgages, according to a study by Nottingham Trent University.
Researchers suggest this is why the UK mortgage market has a shortage of long-term fixed rate products, which protect borrowers from financial shocks.
The findings are the result of a first of its kind examination of how supply-side factors can influence a household’s mortgage choice. It is set to be presented at the European Network of Housing Researchers housing economics workshop on 31 January.
The research was carried out by mortgage experts Professor Michael White and senior lecturer Alla Koblyakova, of the university’s School of Architecture, Design and the Built Environment.
It is based on information obtained from the Bank of England Data Archive, Nationwide house price index data, European Mortgage Federation publications and data from the Council of Mortgage Lenders.
Variable rate mortgages are more profitable for lenders as the risk of interest rate rises is passed on to the borrower.
The research shows that for every year between 2001 and 2008, profit margins on variable rate mortgages for lenders were about 1% higher on average than on fixed rate mortgages.
The only exception to this trend was in 2009 when profit margins for fixed rates and variable rates were roughly the same following substantial cuts to the Bank England base rate.
Professor White said this trend must be taken heed of when examining today’s market.
He said: “Previous research has shown that about 85% of the UK mortgage market is based on variable and short-term fixed rate products, and that an asymmetry towards standard variable rates has the potential to destabilise the economy as a whole.
“Our research shows that the potential reason why the UK mortgage market has an over reliance on variable rate products is because lenders make more money from them, not because they’re necessarily the consumer’s preferred choice.
“This should be of substantial interest to Government bodies and industry investors, as, unlike fixed rate products, variable rate mortgages are highly vulnerable to changes to interest rates, which could be about to increase.”
The research included calculations which show an increased probability for mortgage lenders to promote variable rate products over long-term fixed rate products. Lenders can, for instance, incentivise borrowers to take out variable rate contracts with low product fees and by removing expensive penalties for early redemption.
The study also shows that securitisation – the practice by which mortgage debt is sold as bonds to increase liquidity in the market – provided lenders with the necessary funding to promote long-term fixed rate mortgage products.
Koblyakova added: “The upshot of this study is that variable rate mortgage choice has to a large extent been influenced by supply side factors, rather than by consumer choice.
“Our findings suggest that the difference in profit margins between variable and fixed mortgage rates create incentives for lenders to be biased towards variable rate lending.
“Given the size of mortgage debt in the UK, and recognising that a major share of this debt is either at variable rates or fixed rates for just two years, this raises serious concerns over national financial stability.
“Our findings are consistent with mortgage lending trends, suggesting that larger profit margins from variable and short-term fixed rate mortgages increase the number of variable mortgages taken out in the UK.
“Regulatory and legislative actions need to reconsider risk management in order to encourage a larger share of long-term fixed rate mortgages in the market.”
