Borrowers benefit as banks seek advantage in mortgage price war

The mortgage price war is excellent news for consumers who will see substantial savings on home loans. The State's two biggest banks have surprised everybody with the speed and scale of their response to Bank of Scotland's entry to the market.

The banks and building societies have always known that competition from the UK, or elsewhere, was likely given the sheer scale of the profit margins they were taking on mortgage business. Most had started drawing up contingency plans.

But they were surprised by the competitiveness of Bank of Scotland's opening offer. Those inside the big institutions who argued that the newcomer should be targeted before it became too established soon won out. The threat was not just to the mortgage business of the domestic players, but also the possibility of a wholesale attack on all areas of their retail banking business.

The banks decided the best approach was to match the Scottish bank's rate before it could present its full range of products. They hoped this would also serve to dissuade other UK and continental lenders from entering the market.

Both banks were determined to grab the weekend headlines with large-scale rate cuts. At the end of the day, AIB beat Bank of Ireland by about an hour. But the latter decided to pitch its main variable rate slightly lower - at 3.95 per cent compared to AIB's and Bank of Scotland's 3.99 per cent.

Lower mortgage costs are also likely to fuel the property market as houses become more affordable. A £100,000 (€127,065) loan, for example will now cost just over £600 a month to service, compared with £820 a year ago.

Besides hoping to neutralise Bank of Scotland, the main banks are also targeting market share. Mr Aidan Clarke, managing director of mortgages at AIB, sees AIB's "natural share as 25 per cent" - its current level is 15 per cent. He plans to use new technologies to cut processing costs toward the lower ones prevailing at UK lenders such as Bank of Scotland. Bank of Ireland is also hoping to increase mortgage share.

The decision to match Bank of Scotland will be far more difficult for smaller lenders, who will see the reductions eat into profit margins. But at 3.99 per cent the basic variable mortgage rate is still 1.49 percentage points above the official Interbank rate of 2.5 per cent. This is not an unreasonably low profit margin by historical standards.

Irish Permanent was probably hoping it could get away with only cutting half a point off its variable rate leaving it at 4.75 per cent. Its calculation that the banks would then fall in behind this proved wrong. It will now have to make a further cut along with other lenders such as EBS.

First Active has been left in a particularly sticky position. It announced rate cuts but only to its fixed-rate products and a discounted variable rate for new borrowers.

In recent months increasing numbers of people have been taking out fixed-rate mortgages as longer term rates move up in the money markets. First Active is of course hoping to capitalise on this while it may also hope that pointing to a one-year discount of 3.99 per cent will be enough to attract new customers.

The scale of the cuts shows the extent of the profit margins which the banks were taking and which were reflected in their overflowing coffers. The question now has to be how quickly rates on other products such as personal and business loans and credit cards will fall. Here too there is ample scope for a UK lender to attack.