Bonds may lead to cheap loans

More fixed rate and cheaper mortgages may be on the way if Government proposals for legislation which will provide for mortgage bonds are adopted. The bonds will allow lenders to raise finance more cheaply than they can otherwise.

The bonds, which are a big part of the lending scene in Germany, France, Luxembourg and Denmark will also mean that lenders are likely to offer more fixed rates over longer terms than they do currently.

In Germany, for example, many loans are for a 20-year period and borrowers effectively make the same repayment for their entire loan time. In contrast, here and in the UK, up to 90 per cent of the mortgage market is in variable rates or fixed rates for less than 2 years.

Lenders such as EBS and the German IFSC bank, Depfa, have been lobbying hard for the introduction of the legislation. According to Mr Martin Walsh, head of lending at EBS, the bonds will mean the society will be able to raise more finance in a more cost-effective way than is possible at the moment. This will then be passed on to customers as cheaper loans.

The money will be in long term fixed rates but the society and other lenders will also be able to swap this into variable rates making these cheaper for borrowers.

Over the past few years, lenders have moved away from simply funding mortgages out of the deposits they have on hand. "Securitisation", where the lender sells off the mortgages, are part of this. However, bonds allow the lender to keep control of the loans and are also generally cheaper than securitisation and will cut margins again.

In the past, lenders often took a 2 per cent margin over the inter-bank rate. Huge increases in productivity as technology has been introduced has cut this to around 1.5 percentage points now or even below and this will fall gain after the bonds are introduced, which effectively cuts the middleman out of the loop. For example, if the main European Central Bank's rate is 4.75 per cent, in the past that would have meant a variable rate of 6.75 per cent. At the moment variable rates are around 6.2 per cent but after the legislation is passed, that could drop to around 5.8 per cent. In Germany and other countries, the bonds are also used by local authorities and for public building.

However, the bad news is that huge redemption penalties are still likely to be around. Lenders justify these penalties - which can be as much as one month's interest for every year outstanding on the fixed rate - by pointing to the expense of getting out of the fixed contract they have entered into on the money markets, However, the penalties in other jurisdictions are not as severe.

It is possible that lenders could make long term fixed rate loans slightly more expensive and use the extra funds to effectively pay for an insurance policy which would allow people to either pay off a fixed rate early or move mortgages without incurring huge penalties.

If that were to happen the whole Irish mortgage market could be transformed with borrowers no longer vulnerable to short term cuts and hikes by the Central Bank.