Higher mortgage rates are here to stay

Allister Heath
SO Nationwide is offering a mortgage that will allow some of its customers suffering from negative equity to move homes. So far, so mundane &ndash; but the loan will be worth 125 per cent of the value of the new property. I spent an hour debating this with David Kuo of Motley Fool, the popular personal finance website, on an LBC radio call-in show yesterday afternoon; I suspect most listeners believed irrational exuberance is slowly creeping back. <br /><br />The evidence suggests otherwise.&nbsp; Take the Nationwide product: it requires a five per cent deposit, so it is not as risky as it sounds. I almost never approve of loans worth more than the value of the collateral &ndash; they are based on the idiotic notion that house prices will never drop &ndash; but this particular one might actually make sense for a small number of people. During the previous recession, millions were stuck in homes worth less than their mortgages. They couldn&rsquo;t move to get a new job, with disastrous consequences; this product may help address this and is a good reason for the FSA to avoid heavy-handed bans on high loan-to-value mortgages. <br /><br />But even if you dislike the Nationwide deal, the overall picture suggests no return to the crazy days. The private sector financial balance&nbsp; (income minus spending for households and companies) had risen from&nbsp; -0.9 per cent of GDP in the third quarter of 2007 (net borrowing) to +7.9 per cent of GDP in the first quarter of 2009 (net saving). Citigroup believes private savings are the highest since 1980. This is being driven by firms &ndash; but many consumers who have gained from ultra-low tracker rates are now overpaying their mortgages to build up equity. True, a dire drop in GDP lifted debt/GDP for the household sector to a record 112 per cent in the first quarter. But this will start falling soon. Debt/GDP for non-financial corporates already fell to 115 per cent from 117 per cent, and debt/GDP for non-bank financials dropped to 163 per cent from 169 per cent.<br /><br />Variable rate and tracker mortgages are stable, but fixed-rate mortgages and unsecured loans are becoming dearer, a consequence of banks being told<br />to reduce their leverage and increase their capital. Margins have shot up, not good for consumers in the short-term &ndash; but over time we need strong banks and we need mortgages that are reasonably priced rather than artificially cheap, which would only fuel another bubble. <br /><br />The average 2-year fixed rate (assuming a loan that covers 75 per cent of the price of the house) has surged from 3.98 per cent in May to 4.47 per cent in June. According to Michael Saunders, economist at Citi, who in recent weeks has produced superb reports on the UK, this is the biggest monthly rise since records began in 1995. The average 5-year fixed jumped 0.63 per point.&nbsp; Rates on a &pound;10,000 loan rose by 0.87 per cent to their highest since 2002. Bank overdrafts rose from 18.61 per cent to 18.97 per cent.&nbsp; Credit is available &ndash; but its price is going up and is divorced from the underlying base rate. Keynesians will cry blue-murder: they think another debt-fuelled spending boom is needed to get us out of the previous credit-driven madness. The rest of us will argue that more reasonably-priced mortgages will help increase savings, ensure the housing market&rsquo;s recovery doesn&rsquo;t get out of hand and help deleveraging. It may feel painful &ndash; but hangovers always are.<br />