Bank warns lenders to cool mortgage frenzy

The Bank of England has warned banks and building societies to cool off the frenzy in the mortgage market by reining back their generous discounted loans and cashback offers.

Bank officials are concerned that lenders are not taking enough account of the risk of a sharp rise in interest rates or a downturn in the economy over the next few years that could bring a return of heavy losses on mortgage lending.

Low inflation should lead to lower average interest rates, but this does not mean an end to volatility in the cost of money, Bank officials believe.

They are also urging lenders to be vigilant in choosing mortgage customers and take more care about the terms on which loans are made. Lenders have also been told to be more open in their accounts about the costs of the deals they are offering and more realistic about the market shares they expect.

The Bank's fears have been heightened by the prospect that several of the largest and most aggressive building societies, including Halifax, are in the process of becoming banks.

At the moment they are not feeling the pain of the mortgage price war because they are cushioned by the large number of savers who are keeping cash in their accounts in expectation of payouts on conversion. This means competition for new savings has eased, taking pressure off bank and building society savings rates.

As a result, the overall profit margins remain at near-record levels, temporarily masking the effect of the mortgage price war. The margin between the standard variable mortgage rate and the instant access savings rate stands at about 4 percentage points.

This high profitability is likely to fall rapidly once societies have paid out conversion windfalls to depositors in the next 12 to 18 months, putting upward pressure on savings rates.

The Bank is concerned that some lenders could be amassing large hidden liabilities. Banks as well as building societies that are about to convert into banks are being told to come clean in their accounts about the cost of cashbacks and discounted mortgages.

Few big mortgage lenders clarify in their accounts the effect of alternative treatments of the costs of cashbacks and discounts and there is an argument in the industry about whether to spread the cost or charge it all in the first year.

Abbey National spreads the cost of cashback offers over a period, lessening the impact, but said in its last annual report that if the whole cost had been taken up-front profits would have been pounds 105m lower. The Bank of England wants this openness adopted more widely.

Lloyds TSB and NatWest are among those that spread the cost of cashbacks over several years while Barclays charges it in the first year - but none of them disclose the amounts. Halifax charges the full cost of cashbacks in the first year.

The Bank's Banking Act report yesterday said: "Over the past year, there has been a noticeable increase in the competition among banks, building societies and other financial services companies for lending to individuals, particularly for home mortgages. Discounted mortgages and "cashbacks" have become common, particularly for first-time buyers, as some lenders have sought to increase market share and overall lending growth in a housing market which has remained subdued."

It cites a number of "good news" trends explaining this, including low inflation, but warns lenders to "continue to assess carefully the terms on which they write business. Caution also needs to be exercised in the methods of accounting which are adopted for any schemes used to induce business".

Comment, page 25

Lending mania: five of the best

Halifax

About to de-mutualise, will discount its standard variable rate by 2.86 per cent until June 1999 for second-time buyers and chuck in a free valuation, worth about pounds 150, into the bargain. However, those wanting to move their mortgages before June 2003 will have to pay a penalty of 3 per cent of the loan in year one and two, rising to 6 per cent in the third year before tapering off thereafter.

N & P

About to be taken over by Abbey National, charges nothing until the end of December this year. A free valuation and buildings and contents insurance is also on offer until then. No mortgage indemnity insurance is charged, a saving of about pounds 1,200 on a standard loan. In return, penalties of up to seven months' interest.

C & G

Owned by Lloyds Bank, throws in a cashback worth 3 per cent of the mortgage advance up to pounds 7,500, plus no mortgage indemnity and a free valuation.

Abbey National

Gives a cashback of 6 per cent up to pounds 6,000, but claims the rebate back in the event of early redemption.

Northern Rock

Another society planning to float, offers cashbacks of 6 per cent up to pounds 9,000. But that sum will have to be repaid in the event of a redemption within the first six years.