Why's my mortgage so expensive?
The Bank of England gave a strong indication this week that interest rates would fall yet further, with another quarter per cent cut likely on 10 April 2008, taking base rate down to 5%. And yet the question many of us are desperately still asking is … why’s my mortgage so expensive?If you were farsighted, or lucky, enough to have taken out a tracker mortgage a year or more ago, one that’s pegged to base rate, then you’ll find your monthly interest payments dutifully following what you used to call Bank Rate. For you, the fall in interest rates is (largely) an unmixed blessing. And yet … as many of us are finding, mortgages aren’t getting any cheaper, in fact rates seem to have been edging up for many. So what’s going on?
The thing you have to remember that they don’t call them the money markets for nothing. Many people derisively refer to money traders in the City as ‘barrow boys’ but actually we think that’s something of a compliment. Your man selling fruit and veg on Berwick Street Market in Soho is as finely tuned to supply and demand, to pricing and shifting stock as anyone on Threadneedle Street. The intersection of supply and demand sets price, excess supply compared to demand depresses price until the excess is shifted. If supply doesn’t meet demand, then price can and will rise, choking off demand until equilibrium is once again attained. The guy on Stall Number One can try and price his tomatoes at £2 a kilo, but if everyone else on the market is selling at £1.90 he won’t shift many … his price has to drop. And that price is set by the wholesale market … how much the traders bought their stock at Covent Garden for that morning: the traders will work to a reasonable profit on wholesale price and thus prices will tend to come into line with each other. On the other side, it doesn’t matter how much you argue with Fred on the stall that your apples only cost 50p a pound yesterday – if the wholesale price is up to 40p a pound today, then he isn’t going to sell them for less than 60p.
Now, returning from our long produce based metaphor, and with apologies to any costermongers out there who are shaking their heads at my maths, the wholesale and retail money markets are just the same. The Bank of England can set the price of money all it likes, but if there’s a shortage of the stuff (and that’s what the credit crunch is) then the price will go up. There’s not a physical shortage of fivers and fifties out there of course – but money supply is based on the circulation of the available notes. And at the moment there is such fear of people defaulting on shaky mortgages (not so much the individuals as the banks who have bought these huge packages of sub-prime debt), that the banks don’t want to lend money to each other. Not for the fear that they won’t get it back, but that they won’t be able to borrow more money to keep their operations going – it’s that hard for them to raise money on the markets. That’s why you’ll hear about the interbank lending rate rising, with this interest rate racing ahead of base rate. It’s costing them more to borrow money, and they have less of it to lend, so rates rise. And that’s why your mortgage is so expensive.