Use interest rate cuts to reduce mortgages
Instead of using the latest cuts in interest rate to reduce mortgage-borrowers’ monthly costs, why not use the saving to reduce their loans? It wouldn’t directly stimulate the economy but it would boost the banks and make people richer.
To refine the idea, direct it at the people with high loan-to-value ratios – those 90 per cent mortgages that are now 110 per cent mortgages thanks to falling house prices. Owners with houses still worth substantially more than their mortgages could still benefit from the interest cut and could spend it.
By keeping monthly mortgage payments at the same level when interest rates are cut, the overpayment will reduce the principal increasing the lender’s security and reducing the owner’s negative equity or boosting their remaining equity.
Perhaps people cannot be forced to spend their interest cut on reducing their mortgage, but they can be encouraged to. A lender could announce one rate cut for those who take it in cash and a higher one for those who use it to reduce capital; or it could announce an immediate cut for those reducing their loan but a delayed one for those wanting cash.
The choice would thus be with the borrower.
At present, house prices are falling faster than the rate at which an interest cut would reduce a mortgage, but the effect on loan-to-value ratios will still be positive. And as that ratio falls, the lender could move the borrower to an even lower interest rate because the loan is better covered by collateral.
As loans – especially risky high-ratio loans – are repaid, the bank’s own balance sheet improves allowing it to borrow more cheaply and it can pass on that gain to all borrowers. Further, as loans are repaid the bank has funds that it can lend to new borrowers, thus helping the housing market or small firms.
Indeed, as the banks’ positions become less risky they will require less taxpayers’ capital and their value will increase, helping the government to exit at a profit.
Of course, homeowners cannot reduce their mortgages and spend the interest cut, but the feelgood of owning more if their homes may provide the confidence to allow those who can do so to keep on spending.
April 15th, 2009 at 3:49 pm
I agree with your logic however on a practiacal note..
1. As your LTV ratio comes down banks are not very forthcoming in moving or even notifying you that you could be on a better rate.
2. Even if we wanted to keep the payments level with all the rate decreases, the banks have not made it easy for you to do so.. my bank has not even asked even though I want to keep paying more to reduce the debt and I don’t know haw it would work (and sometimes it seems too much hassle for people as banks are not providing information in an easily accessible form).
3. Lender are not passing on cuts even to current customers that are coming off fixed rates. Example is that I know someone that came off a fixed rate of 4.89% in October 2008 and now they are paying 4.99% on Alliance and Leicester SVR even though the base rate is 0.5%…
It seeems the banks are still out to rip us off.. when will someone step in and make sure the consumer gets a fair deal. They are not against banks making profits but it seems this is down right racketeering as some people do not have a choice but stay to with the current lender.