European Ruling Set To Make Mortgage Rates Harder To Understand
New European rules could make mortgage rates even harder for customers to understand as Euro bureaucrats want to introduce a new way of calculating interest rates on residential property mortgage loans and experts are warning that this could be a recipe for confusion.
Under the new proposed EU directive, mortgage lenders would be expected to tell borrowers the maximum interest rate they have charged over the past 20 years, and display this figure on all of their literature.
However, industry experts say customers are already confused by the rates that lenders are forced to display, and that this will make it even harder for them to understand mortgage rates.
David Hollingworth from mortgage broker, London & Country, said:”I think that there is a chance that borrowers become overloaded with information and APR rates that mean little to them, and so risk them being ignored altogether, the extra information could lead to more customers failing to shop around and remaining on expensive standard variable rates (SVRs).
The EU credit directive concerning the mortgage change is expected to be approved later this year. It will compel lenders to display a new annual percentage rate (APR) on all of their literature. This will be calculated using the highest level that the lender’s SVR has reached in the previous 20 years.
The new rate will need to be displayed as prominently as other rates, and will apply to most mortgages sold in the UK, since only those that have a fixed period of more than five years will be exempt.
Mortgage companies will have until 2015 to comply with the European legislation.
Mortgage borrowers are already presented with one misleading rate when trying to compare the benefits of different mortgages and this new European ruling would mean new customers would have two rates to choose from as mortgage companies are already obliged to quote an APR based on the current standard variable rate.
This APR is calculated by taking the total interest cost over the 25-year term of the mortgage, plus fees.
Although this rate is displayed prominently, it is quite possible that borrowers will never pay it, because they start off paying a lower rate for a fixed period and then a higher rate for an SVR.
What the currently displayed APR tells borrowers is the average rate they would pay if they kept the mortgage for the entire 25-year period. However, many people intend to switch their mortgage before it comes to an end, meaning that this will not be a useful comparison.
Now, financial experts reckon that customers will be faced with two completely different APR figures, neither of which will tell them what they will pay every month for the life of the mortgage.
Mr Hollingworth added: “Given the fact that the APR is of little help to borrowers in establishing the best deal for them based on the current interest rates, it’s unlikely that an APR based on a worst-case rate scenario based on historic rates will be of much use. Anyone who was intelligent enough to understand the equation by which the new APR had to be calculated, is probably so intelligent they can charge huge fees for their services and would be able to buy a property without needing a mortgage”.
Comparing the cost of different mortgages is already hugely complicated, because some charge upfront fees while others prefer to charge a higher interest rate over the period.
Comparing mortgages based on interest rates alone may not give a good indication of the best deal overall because it does not reflect the total cost of a mortgage.
A recent study by consumer champion, Which? showed that most people could not correctly identify the cheapest mortgage deals.
Which? asked more than 1,000 people to rank five two-year fixed-rate mortgages in order of total cost over the two years. Only 10% could do so correctly and only 25% could identify the cheapest and most expensive deals.
Richard Lloyd, Which? Executive Director said “Our research shows that even people who already have a mortgage struggle to recognise the cheapest deal. Lenders should be more transparent about the true cost of mortgages so that borrowers can more easily compare deals and find the best one for them. The mortgage industry should explore alternatives to the current APR in order to make it easier for consumers to understand.
However, the EU changes will just make comparison more difficult.
Standard Variable Rates have varied considerably over the past 20 years, with the highest bank rate in the past 20 years being 7.5%, and at the time most SVRs were at 2% above the bank rate. The average SVR in 2012 was 3.43%.
Existing mortgage lenders are also concerned that newer entrants to the market will be able to display rates that look far lower than theirs, while entirely new mortgage lenders will be able to avoid compliance with the new stipulation for a few years.
For a mortgage lender who has only begun offering mortgages within the past four years, the bank rate will have been 0.5% for their whole time of operation. Hence their SVR will be based on a Bank Rate of 0.5%, whereas for long-established lenders it will be based on a Bank Rate of 7.5%.
Other European members, including Latvia and Luxembourg, have already voted against the wording of the text in the legislation and a spokesman for the two countries said that “both professionals and consumers stand to lose as a result of this text, which has no added value”.
However, economists still expect the proposal to be introduced and customers are advised to focus on value when seeking a mortgage, rather than just looking at the lowest headline rate, as they feel it would be very difficult to come up with a universal measure to show the true value of a mortgage, as there are so many factors to bear in mind.
To do this, mortgage customers need to look at the fees being charged and the cost of the mortgage over the time that they are intending to need it, and then calculate their own monthly payments.
Borrowers also need to factor in the cost of remortgaging at the end of the fixed period if they do not intend to stay on a lender’s Standard Variable Rate.
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