So what is the interest rate?
So what is the interest rate? I was asked this question by an exasperated friend this week who, having spent weeks casting around for a mortgage, was mortified to find all the best rates being withdrawn just as the Bank of England cut Base Rate from 4.5% to 3% this week - the biggest cut since the early 1980s, and resulting in the lowest base rate since 1955. The same friend had already had an ‘in principle’ mortgage with the Halifax withdrawn at the eleventh hour, despite having paid for a survey on the property (it came back with a favourable report) and only asking for a 75% mortgage. Yet this good risk (by most criteria I could see) had the rug pulled and, trying to find a new deal, discovered that lenders were still offering around 6%.
The point is of course that there isn’t one interest rate. There is the much talked of ‘base rate’, currently at 3%, and this is the rate (plus a small premium) that the banks borrow money ‘wholesale’. They then lend that money on to you, in the form of mortgages and other loans. And they make a margin on this - fair enough, they are businesses. Most of us are quite happy to pay this, when the banks are borrowing at 5% as they were a year or two ago and lending it to you at 6%. In fact, in the heady days of lending, you could often get a fix at below the then current base rate, as they would use this as a loss leader, to hook you in. After your term was up, they would rely on customer inertia to see you slipping unnoticed onto the standard variable rate.
But when they are borrowing at 3% and lending at 6%, we are not simply seeing an historically high gap between base and lending rates, we’re also seeing astonishing markups - 100% in the above case. There are a number of reasons for this. The freeze in credit means that it’s hard for the banks to borrow money from each other, and that makes the interbank lending rate (LIBOR) rise. So they are borrowing at much above base before they can lend to you. These illiquid and poorly capitalised banks are also trying to rebuild their balance sheets, get more cash on board in other words, so they are hoarding the stuff. Nobody wants to be the next Northern Rock and suffer a run on assets. All these factors make the interest rate rise. And all conspire to make that mouthwatering 3% or anything near it just a dream for ordinary borrowers. In answer to my friend’s question - the interest rate is the one you can get!
