The European Union has proposed a directive to require mortgage lenders to display a historic figure for mortgage interest rates alongside the usual APR (Annual Percentage Rate). This second rate is meant to improve public understanding of uncertainty surrounding future interest rates.
However, it may not work.
This second APR shows borrowers the maximum standard variable rate (SVR) lenders have charged over the previous 20 years. This figure for the historic SVR would have to appear prominently in all advertising for mortgages with variable or fixed rates lasting less than five years.
The assumption is that this will encourage applicants to think about the affordability of mortgage deals, understanding that interest rates can be a roller-coaster ride.
The European Parliament is expected to approve new mortgage rules in September, from which point the UK and other EU states have two years to enshrine these rules in law. So if approved, this second APR would appear in mortgage adverts from 2015 onwards.
Double troubleGiven that APRs are already fiendishly complicate to calculate, it seems alarming that another -- and very different -- rate could be added to mortgage adverts and quotations. Indeed, industry experts have warned that this 'worst-case APR' will have the opposite effect of that intended. They claim that it will needlessly confuse mortgage borrowers, making the process of choosing a home loan even more complicated.
Another critic of this proposal, Your Mortgage Decisions director Dominik Lipnicki, says: "To add another APR on top of an APR that is already useless to most clients is mad. We need more localised regulation and not an EU-wide APR initiative."
Other EU states have criticised the proposed rule, with Latvia and Luxembourg both voting against the draft wording. These two states warned: "Both professionals and consumers stand to lose as a result of this text, which has no added value."
Yet another problem arises when new lenders enter the market. With no historic lending record, they cannot display this second APR. This lack of historical comparison might create a loophole for new lenders, allowing them to produce seemingly more attractive advertising and potentially lure borrowers through misleading marketing.
The riddle of ratesIn addition, producing a new APR figure based on rates over the past two decades could be highly misleading, particularly over the coming decade. According to trade body the Council of Mortgage Lenders (CML), the average mortgage SVR was 7.67% a year in 1993. This average remained comfortably above 6% until 2001, when rates started to fall steadily. Last year, the average SVR was 3.43% a year -- less than half the average rate charged 20 years ago.
Since March 2009, the Bank of England's base rate has remained at 0.5% a year, the lowest level since the Bank was formed in 1694. Thus, for more than four years, the base rate and mortgage rates have plumbed depths never before seen in British banking history.
Of course, with such ultra-low rates, the only way is up. Over the coming decade, as our national debt continues to mount, the Government's borrowing costs will surely rise. This will push up the yields (interest rates) paid by UK Government bonds, known as gilts. As 'risk free' gilt yields rise, other interest rates will follow suit, forcing up borrowing costs for individuals and companies.
In other words, the ultra-low interest rates we've seen over the past few years are likely to be an extremely poor guide to the higher rates expected in the years ahead.
A simple alternativeWhen it comes to investment advice, financial promotions must state clearly that "the past is no guide to the future" when referring to previous investment returns. So why remind consumers of the past when choosing mortgages, but not investments?
I believe that what the EU has tried to do is sensible, but what started out as a good idea has been let down by poor delivery. Instead of forcing lenders to include an APR based on two decades of historic rates, how about a simple warning about rates instead?
For example, all UK mortgage literature must include the following caveat, "Your home may be repossessed if you do not keep up repayments on your mortgage." Likewise, it would be easy to require mortgage lenders to add a generalised warning about rates, such as: "The general level of interest rates has varied widely over time. Future mortgage rates may be considerably higher than those charged today, so be sure to budget for higher monthly repayments in future."
I suspect that a message of this kind would be less confusing than adding another complicated figure to mortgage illustrations.