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Mortgage lenders were facing a difficult balancing act last night to keep their mortgage and savings customers happy after the Bank of England's deeper than expected interest rate cut.
Experts predicted that the 150 basis point cut could leave lenders facing losses on their tracker mortgages because they are funding the products in the money markets, where Libor (London interbank borrowing rate) is 5.56%. This means lenders are borrowing at more than they are able to charge customers with tracker rates, which will automatically fall in line with the new base rate of 3%.
Lenders are also desperate to offer attractive savings rates to lure in customers and to help close the £740bn gap between the loans they have granted and the amount of money they have on deposit for savers.
The biggest problem could be for those lenders which have started to offer tracker rates in recent months. Older tracker deals may not be so problematic as the lenders may have hedged their exposure, taking out a kind of insurance policy on the money markets to protect against dramatic changes in rates. It is likely that there will dramatic revisions to mortgage and savings rates in the coming days.
Ray Boulger of mortgage brokers John Charcol said: "Any lender that was offering trackers in the last six months will be facing very big losses. If Libor does not drop by at least 1%, then lenders' margins are going to come under intense pressure.
"Most lenders do have in their small print a get-out clause that allows them, in extreme circumstances, to change the tracker rate that a borrower pays, but doing so would cause them ... negative publicity and would probably be disallowed by the Financial Services Authority."
Ordinarily, an interest rate cut is seen as good news for banks as it makes it less likely that customers would have difficulty making payments on debts.
But Ian Gordon, banks analyst at Exane BNP Paribas, said it is not always so simple - especially in the current market where the gap between official rates and Libor has widened. Over the decade the gap between official rates and Libor has averaged 0.16%. Before yesterday's cut it was 10 times that amount. Unless Libor falls dramatically today, that gap will widen.
According to some estimates tracker mortgages account for 40% of the outstanding mortgage market or about 4 million households.
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