Record lending rates: a rip off?

Bank of EnglandCarl Court/PA Wire/Press Association Images

The average gap between the Bank of England interest rate and the rate we are being charged to borrow money on mortgages, credit cards and overdrafts has grown to a new record. The Daily Telegraph is up in arms, about it

So are we being ripped off, or is this neglecting a massive part of the story?

Record highs

There's no arguing with the facts: The Daily Telegraph showed that the gap between the Bank of England base rate and the average mortgage rate is now the highest since records began 17 years ago, while the average lending rate on overdrafts is 19.5%, a new high, and credit card average rates are now 17.3% - the highest for 11 years.

This isn't the last of it. Halifax has hit the headlines for raising the cap on its SVR, which many pundits believe will feed through into a higher SVR before the summer - and it's unlikely to be the only company to do so.

This is all taking place at a time when the Bank of England's base rate has been sitting at 0.5% for three years, so you would be forgiven for thinking that interest rates should be particularly low.

So are we being ripped off?

Ray Boulger, senior technical manager at mortgage broker Charcol says this isn't necessarily the case.

He explains: "The cost of raising funds for banks and building societies has disconnected from the Bank of England base rate. While there are a number of products ostensibly linked to the Bank of England rate, it bears less and less resemblance to the rates they have to pay to raise funds. So comparing markets using the base rate as a benchmark is not that meaningful."

Banks pay more

Boulger points to the fact that before the credit crunch, the rate the banks could borrow money at (known as the 3 month libor) was 15 basis points above the Bank of England base rate. Right now, it is 55 basis points above the base rate. Fundamentally, it costs the banks more to raise money.

He also highlights that we are simultaneously enjoying the flip side. Back before the credit crunch when the base rate was 5.75%, the top savings rates were around 7% - a differential of 1.25%. Now with the base rate at 0.5%, top rates are around 3%, so the differential is 2.5%.

Banks earn less

In addition, he says you need to look more broadly at the ways banks are funded, which means that whenever the base rate comes down, the gap between it and the average SVR always tends to grow. This is exactly what happened back in 2003, when the average gap went from 2% to 2.5%.

He explains: "Banks get some of their risk-free money from the fact that money is held practically interest-free in current accounts. When the interest rate is 6%, they are making a big bonus from the money in current accounts. When it is just 0.5% they are making far less, so the money has to come from somewhere else."

So will we get any relief soon?

Unfortunately, Boulger doesn't see the end of the tunnel approaching just yet. He says: "The best solution is competition, and there just isn't enough cash in the system to promote competition. Until the Eurozone crisis is resolved that isn't going to change, so we can expect money to be tight for a few years yet."
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