UK Mortgage Terms for the Confused American
October 21, 2022 12:12 PM Subscribe
One confusing aspect of the ongoing monetary/leadership crisis in the UK has been the detail that so many homeowners in Britain have "fixed" mortgage terms of only two or five years, with a reported ⅓ of borrowers facing a sharp increase in costs over the next year. In the US a fixed mortgage term is often 30 years. Why is there such a big difference in lending practices?
The thing that a Briton would call a five year fixed mortgage looks a lot like what in the US would be called an adjustable rate mortgage (ARM) with an initial five year lock. ARMs are increasingly unpopular in the US, with currently fewer than 10% of home buyers choosing them. From the information I can find the longest fixed mortgage on offer in the UK is ten years, and most people seem to choose fixed terms of only two or five years. The common 30-year fixed mortgage an American might choose is simply unavailable in the UK.
I would love a pointer to an explainer that gets into the difference in banking rules, tax incentives, and whatever other traditions have led to such a striking difference in monetary policy. Is this simply a result of an adherence to tradition, or does the US have tax incentives (or other regulatory frameworks) that have created a market with rules so starkly different from those in the UK?
The thing that a Briton would call a five year fixed mortgage looks a lot like what in the US would be called an adjustable rate mortgage (ARM) with an initial five year lock. ARMs are increasingly unpopular in the US, with currently fewer than 10% of home buyers choosing them. From the information I can find the longest fixed mortgage on offer in the UK is ten years, and most people seem to choose fixed terms of only two or five years. The common 30-year fixed mortgage an American might choose is simply unavailable in the UK.
I would love a pointer to an explainer that gets into the difference in banking rules, tax incentives, and whatever other traditions have led to such a striking difference in monetary policy. Is this simply a result of an adherence to tradition, or does the US have tax incentives (or other regulatory frameworks) that have created a market with rules so starkly different from those in the UK?
Correct, a UK fixed mortgage is what would be called an ARM in the US.
My best guess is that, generally speaking, banks prefer ARMs because it transfers risk from them to the customer. If that's true, the thing you need to explain is not: "why do they use ARMs in the UK?", but "how do US banks offer affordable fixed mortgages?" I assume the answer to that is that the federal government is a participant in the mortgage market via Fannie Mae and Freddie Mac. This allows the banks to reduce the price of the risk associated with fixed loans, such that they become affordable to consumers. This is not how things work in the UK (or most of the world AFAIK).
posted by caek at 12:34 PM on October 21, 2022 [5 favorites]
My best guess is that, generally speaking, banks prefer ARMs because it transfers risk from them to the customer. If that's true, the thing you need to explain is not: "why do they use ARMs in the UK?", but "how do US banks offer affordable fixed mortgages?" I assume the answer to that is that the federal government is a participant in the mortgage market via Fannie Mae and Freddie Mac. This allows the banks to reduce the price of the risk associated with fixed loans, such that they become affordable to consumers. This is not how things work in the UK (or most of the world AFAIK).
posted by caek at 12:34 PM on October 21, 2022 [5 favorites]
It’s the same in Canada as in the UK. We generally have long amortization periods (25 yrs) but short mortgage terms (10 years are available but 5 and under are more common). At the end of the term you either renew or you owe whatever the balance is.
Terms can be either fixed rate or variable rates, and some variable rates can also be locked in when the borrower wants. When interest rates were going down the variable rates worked in the borrower’s favour. Now it’s the reverse and definitely we’re seeing an impact.
posted by warriorqueen at 1:09 PM on October 21, 2022 [3 favorites]
Terms can be either fixed rate or variable rates, and some variable rates can also be locked in when the borrower wants. When interest rates were going down the variable rates worked in the borrower’s favour. Now it’s the reverse and definitely we’re seeing an impact.
posted by warriorqueen at 1:09 PM on October 21, 2022 [3 favorites]
Response by poster: OK, so digging a bit along these lines I see that Fannie Mae and Freddie Mac were created by the US government to establish the secondary mortgage market, but neither of them is actually backed by the full faith and credit of the US government the way Ginnie Mae is. I guess my actual question is: if 15 and 30 year mortgages are the product of the secondary mortgage market with only-kinda-sorta backing from the US government, where's the secondary mortgage market in the UK?
NOTE: I understand the 2000s banking crisis happened and that financialization without regulatory oversight is perilous, but that doesn't mean that financialization can't work at all. If Fannie Mae and Freddie Mac could underpin the secondary mortgage market in the US for decades without federal backing (2000s banking crisis aside), why don't other countries have the same sort of financialization happening?
posted by fedward at 1:10 PM on October 21, 2022
NOTE: I understand the 2000s banking crisis happened and that financialization without regulatory oversight is perilous, but that doesn't mean that financialization can't work at all. If Fannie Mae and Freddie Mac could underpin the secondary mortgage market in the US for decades without federal backing (2000s banking crisis aside), why don't other countries have the same sort of financialization happening?
posted by fedward at 1:10 PM on October 21, 2022
UK has much higher population density than a lot of the USA and a much more regulated financial services industry, having also consolidated many credit unions (here they're called "Building Societies") into the profit-making high-street banks.
We had a lot of good municipal housing stock sold at knock-down rates in the 1980s when a "right to buy"was promised to the tenants of local council houses. We never rebuilt the stock for people who need it, and that's turned property into a savings investment. So versus inflation and for retirement lifestyle choices, property prices have a slim margin to interest rates.
The other thing the secondary mortgage market does is balance risk (Fannie Mae and Freddie Mac helping trades in bundled mortgages so that smaller regional banks can manage their lending). Instead we've got regulations for cash holdings at banks and financial entities to protect against consumer defaults, fraud and bank runs.
posted by k3ninho at 2:08 PM on October 21, 2022
We had a lot of good municipal housing stock sold at knock-down rates in the 1980s when a "right to buy"was promised to the tenants of local council houses. We never rebuilt the stock for people who need it, and that's turned property into a savings investment. So versus inflation and for retirement lifestyle choices, property prices have a slim margin to interest rates.
The other thing the secondary mortgage market does is balance risk (Fannie Mae and Freddie Mac helping trades in bundled mortgages so that smaller regional banks can manage their lending). Instead we've got regulations for cash holdings at banks and financial entities to protect against consumer defaults, fraud and bank runs.
posted by k3ninho at 2:08 PM on October 21, 2022
Probably because it doesn't really add much in the US. It doesn't impact pricing much. It doesn't give the US a particularly higher than average home ownership rate. It doesn't lead to an increase in minority or financially underprivileged home ownership rate.
It doesn't really lower rates much, as rates in the US not subsidized by the US Federal Government are often equal or lower than Federally backed rates.
Fanny and Freddie had no role in the 2000s crisis. That people think they were is not based in any actual facts. Because it wasn't actually a housing/lending crisis.
posted by The_Vegetables at 3:46 PM on October 21, 2022
It doesn't really lower rates much, as rates in the US not subsidized by the US Federal Government are often equal or lower than Federally backed rates.
Fanny and Freddie had no role in the 2000s crisis. That people think they were is not based in any actual facts. Because it wasn't actually a housing/lending crisis.
posted by The_Vegetables at 3:46 PM on October 21, 2022
Fanny and Freddie had no role in the 2000s crisis.
Sure they did. They bought a buttload--nay, a metric shit-ton--of bad paper. (FHFA was Fannie and Freddie's conservator.) Propped up demand.
posted by praemunire at 5:39 PM on October 21, 2022
Sure they did. They bought a buttload--nay, a metric shit-ton--of bad paper. (FHFA was Fannie and Freddie's conservator.) Propped up demand.
posted by praemunire at 5:39 PM on October 21, 2022
As mentiond aboved, Fannie and Freddie are Government Sponsored Enterprises created by Congress to grease the wheels and absorb risk in the secondary mortgage market, giving lenders somewhere to offload their risk. As such, it is assumed that they generally would be bailed out by the US federal government (being products of government). This is precisely what happened in 2008 when they were placed in conservatorships by FHFA. Having this implicit backing means they are able to issue debt (known as agency debt in market lingo) at yields just slightly above the US Treasury. That easy access to cheap capital via the implicit guarantee, and the secondary market functions they provide, makes mortgage lending cheaper / less risky for lenders in the US (and, as touched on above as well, in cases has completely distorted and perverted the market).
posted by ExpertWitness at 6:48 PM on October 21, 2022 [1 favorite]
posted by ExpertWitness at 6:48 PM on October 21, 2022 [1 favorite]
A "fixed" mortgage has a fixed interest rate for a specified period. The term of the mortgage is unchanged.
If interest rates are currently low, but you expect them to rise, you might prefer to choose a fixed rate to lock in a lower interest rate for the next few years.
If rates go down instead you may end up paying more than you would on a floating rate.
When the fixed period lapses, you need to either choose a new fixed rate, or go to a floating rate. Changing to a different rate before this can be done but will usually incur a fee.
TLDR: "fixed" mortgage terms is misleading. The term of the mortgage isn't affected, it's the interest rate that is fixed for a specified time.
posted by HiroProtagonist at 6:28 PM on October 24, 2022
If interest rates are currently low, but you expect them to rise, you might prefer to choose a fixed rate to lock in a lower interest rate for the next few years.
If rates go down instead you may end up paying more than you would on a floating rate.
When the fixed period lapses, you need to either choose a new fixed rate, or go to a floating rate. Changing to a different rate before this can be done but will usually incur a fee.
TLDR: "fixed" mortgage terms is misleading. The term of the mortgage isn't affected, it's the interest rate that is fixed for a specified time.
posted by HiroProtagonist at 6:28 PM on October 24, 2022
the thing you need to explain is not: "why do they use ARMs in the UK?", but "how do US banks offer affordable fixed mortgages?"Tooze shared a chart today that confirms that, among rich western countries, the US is the outlier, not the UK (see "How fixed is your interest rate? This is really going to hurt "). Every country except Germany and the US has a majority of mortgages fixed for less than 5 years. Many countries have a majority fixed for less than 1 year (or not at all).
posted by caek at 12:32 PM on November 2, 2022
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posted by wierdo at 12:20 PM on October 21, 2022 [4 favorites]