Why are banks not offering high interest mortgages?

dzug1

ILW wrote: »

I was not suggesting lending to high risk borrowers, but low risk borrowers who are not able to come up with a £30-40k deposit. Possibly a 5% deposit and then 10% fixed rate for say 5 years with a high ERC would be a perfectly sound business model.

Perhaps those who cannot come up with the deposit are viewed as high risk borrowers.

Blacklight

Seems to me there's a lot of complaining about people not being able to get a mortgage with less than £40k in the bank. There are a lot of 95% deals out there. What are people trying to buy as a first house?

michaels

I think the OP model does make sense - after all you can afford a pretty high default rate at 10% interest as the loss on default will only be at most 20% of the loan.

However there are 2 issues against:
1) Negative self selection - those wanting such a high LTV have demonstrated that they are not able to manage their finances in such a way as to save for a deposit so may well lack the discipline to have a mortgage
2) Banks capital position - capital is scarce - a high rate suggests a high risk of default and thus a requirement for the bank to hold lots of capital which most banks do not want to tie up at present.

Plus the reputation risk of lots of repossession already mentioned above.

Generali

Default is a nightmare from a bank's pov. There's a load of negative publicity involved 'Evil Bank Takes Family's Home', they lose out on perhaps 6 months mortgage interest payments which at an interest rate of 10% would be in excess of 5% of the outstanding balance alone, on top of that there are legal costs and a whole load of hassle oh and loads of people that get repossessed smash up the property so it's worth less than the bank thought when they lent the money.

Why bother with all that hassle when you can lend 70% of the value of a property to someone with a perfect credit record. You can borrow the funds from the BoE at 0.5% and lend them out at 3-4%. Plus if you make a loss the good old British taxpayer will bail you out.

Strings

The banks are making enough money as it is without the need to take on what they perceive as risky lenders.
As mentioned in a previous post, if you can not save the deposit, or have means to do so, then what is to say that you can afford to pay the mortgage payments year on year. Having a deposit also spreads the risk of negative equity , but also gives the owner with a large deposit affordable mortgage payments due to lower mortgage rates, something we are seeing now.

It seems a case that the banks are willing to reward those who have saved with good interest rates.

princeofpounds

Because the internal capital allocation model (with appropriate regulatory constraints) the banks run is telling them that the more conservative lending has higher net present value.

Sorry for the jargon, but that's the reason. And it takes into account all of the points raised above and more.

Banks only have a finite amount of capital. They perform continuous analyses to make sure it is deployed the best way. They use net present value analysis to determine the value created by any particular lending decision, which basically means they estimate the current value of the stream of future cashflows.

You are very right to ask why the cost of risk (the statistical % lending margin needed to cover defaults) can't just be offset with a higher interest rate. There are several reasons. Often the cost of risk just makes the debt unaffordable (remember it's about demand for loans as well as for supply of loans). Sometimes a loan may be more profitable in cash terms but not worth the risk to the bank - riskier projects have a lower net present value as there is more uncertainty. Often there are odd quirks that make risk effects disproportionate (such as home owners with little equity defaulting more than they 'should' just because they have less skin in the game)

Sometimes this deployment is constrained by regulation. You can have a very profitable loan but if it is expensive in terms of the bank's own equity capital that needs to be set aside to maintain it then the profit per unit of equity capital (which is what they fundamentally care about) is not necessarily so high.

This is particularly important in the current environment where banks have little capital as a result of the losses from the credit crunch and the fact that the markets don't want to give them much more. So a high-collateralised loan can be a very attractive option for a bank with deficient capital as the regulators might see it as very safe and it's one of the few ways they can actually grow lending.

Hope that helps. It's not a precise description as I haven't spent time on making it very articulate, but should give you a general idea of how these things work.

Damaged

thread closed

sabretoothtigger

payday loan interest is a thousand percent

The initial amount ventured is small but with mortgages the risk of payee bankruptcy or loss for the bank is greater.
Its not there mostly because its not viable for people to do this and if it doesnt compare well to renting and saving then its not viable for the bank.

Partly its not there due to regulations and government interference in the free market or some cowboy finance company would certainly be happy to wipe people out daily.
The best example I can remember is buying out pensioners homes and renting it back to them, the firm made it totally infeasible for them to stay in their homes due to 'service fees'