Mortgage rate confusion created by EU meddling

EU meddling to create mortgage rate confusion

The EU wants to introduce a new way of calculating interest rates on home loans – a recipe for confusion.
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Rosie Murray-West By Rosie Murray-West7:24AM BST 30 Jun 2013Comments2 Comments

New EU rules will make mortgage rates even harder for customers to understand, experts have warned.

Under a new directive, lenders are expected to tell borrowers the maximum interest rate they have charged over the past 20 years, and display this figure on all of their literature.

However, industry experts say customers are already confused by the rates that lenders are forced to display, and that this will make it even harder for them to understand mortgage rates.

“I think that there is a chance that borrowers become overloaded with information and APR rates that mean little to them, and so risk [them] being ignored altogether,” said David Hollingworth from London & Country, the mortgage broker. He said the extra information could lead to more customers failing to shop around and remaining on expensive standard variable rates (SVRs).

The EU credit directive concerning the mortgage change is expected to be approved later this year. It will compel lenders to display a new annual percentage rate (APR) on all of their literature. This will be calculated using the highest level that the lender’s SVR has reached in the previous 20 years.

The new rate will need to be displayed as prominently as other rates, and will apply to most mortgages sold in Britain, since only those that have a fixed period of more than five years will be exempt. The mortgage companies will have until 2015 to comply with the legislation.

Ray Boulger of John Charcol, another broker, described the new rule as “crackpot”. He said customers were already given one misleading rate when they were trying to compare mortgages, and that this rule would mean that they would have two.

Mortgage companies are already obliged to quote an APR based on the current SVR. This APR is calculated by taking the total interest cost over the 25-year term of the mortgage, plus fees. Although this rate is displayed prominently, it is quite possible that borrowers will never pay it, because they start off paying a lower rate for a fixed period and then a higher rate for an SVR.

What the currently displayed APR tells borrowers is the average rate they would pay if they kept the mortgage for the entire 25-year period. However, many people intend to switch their mortgage before it comes to an end, meaning that this will not be a useful comparison.

Now, experts say, customers will be faced with two completely different APR figures, neither of which will tell them what they will pay for the mortgage.

“The two APRs will be massively different, except for lenders who have only been offering mortgages for a maximum of four years, and thus will result in most borrowers being totally confused,” Mr Boulger said.

Mr Hollingworth added: “Given the fact that the APR is of little help to borrowers in establishing the best deal for them based on the current interest rates, it’s unlikely that an APR based on a worst-case rate scenario based on historic rates will be of much use.” He said anyone who was intelligent enough to understand the equation by which the new APR had to be calculated “is probably so intelligent they can charge huge fees for their services and would be able to buy a property without needing a mortgage”.

Comparing the cost of different mortgages is already hugely complicated, because some charge upfront fees while others prefer to charge a higher interest rate over the period. Comparing mortgages based on interest rates alone may not give a good indication of the best deal overall because it does not reflect the total cost of a mortgage.

A recent study by Which? showed that most people could not correctly identify the cheapest mortgage deals for them. The watchdog asked more than 1,000 people to rank five two-year fixed-rate mortgages in order of total cost over the two years. Only one in 10 could do so correctly. Just a quarter could identify the cheapest and most expensive deals.
“Our research shows that even people who already have a mortgage struggle to recognise the cheapest deal,” said Richard Lloyd, Which? executive director. “Lenders should be more transparent about the true cost of mortgages so that borrowers can more easily compare deals and find the best one for them.”

He said the industry should explore alternatives to the current APR in order to make it easier for consumers to understand.

However, the EU changes will just make comparison more difficult. SVR rates have varied wildly over the past 20 years. The highest the Bank Rate has been in the past 20 years is 7.5pc, and at the time most SVRs were at 2pc above Bank Rate. The average SVR in 2012 was 3.43pc.

Existing mortgage lenders are also concerned that newer entrants to the market will be able to display rates that look far lower than theirs, while entirely new entrants will be able to avoid the stipulation completely.

“This rule will throw up many anomalies,” said Mr Boulger. “For a lender who only started offering mortgages within the past four years, Bank Rate will have been 0.5pc for their whole period of operation. Hence their SVR will be based on a Bank Rate of 0.5pc, whereas for long-established lenders it will be based on a Bank Rate of 7.5pc.

Several nations, including Latvia and Luxembourg, have already voted against the wording of the text in the legislation. A spokesman for the two countries said that “both professionals and consumers stand to lose as a result of this text, which has no added value”.

However, Mr Hollingworth said he still expected the proposal to take effect. He advised customers to focus on value when looking at a mortgage, rather than just looking at the lowest headline rate. “It’s very difficult to come up with a universal measure to show that, as there are so many factors to bear in mind.”

To do this, mortgage customers need to look at the fees that they are being charged and the cost of the mortgage over the time that they are intending to hold it, and then calculate their own monthly payments.

They also need to factor in the cost of remortgaging at the end of the fixed period if they do not intend to stay on a lender’s SVR.

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