Brendan Burgess
Founder
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It was so obvious to me that passing on rate cuts to new customers only was blatantly unfair and in breach of the Consumer Protection Code, that I did not bother to make out the argument. But as a few people have questioned it, I thought it worth setting out the arguments in a systematic manner.
Note: This is a long post!
Introduction
Imagine a market where lenders are obliged to pass on rate cuts equally to new and existing customers and where incentives for new business are prohibited. If a lender wants to compete for new business by cutting the rate for <80% LTV mortgages, they would have to cut the rate for their existing book of <80% LTV mortgages.
It would be much easier for the borrower to make an informed choice. They would be presented with something like the following information
KBC is clearly the cheapest lender, unless the borrower is borrowing over €200k and less than 80% LTV.
Bank of Ireland will only get business from customers who don’t shop around. So what will happen is that Bank of Ireland will be forced to compete by cutting rates.
Any customer who is prepared to shop around, will be able to see very quickly where the best deal is for them.
Over time, another lender may become cheaper than KBC. But a borrower will not find themselves taking out a mortgage with KBC, only to find KBC cutting rates for new customers only.
If one is relying on competition alone to solve the problem, then obliging lenders to offer existing customers the rates available to new customers is essential. Otherwise, most existing customers will not benefit from any increase in competition.
It is very important that the lenders are obliged to charge new and existing customers the same rates. If not, KBC may cut the rates for new customers only. Existing customers would not benefit from competition. Of course, those who could switch, might switch. But many can’t switch, and even for those who can, it’s time consuming and expensive.
Limiting cash incentives to the cost of switching is essential is we are to rely on competition
A lender could get around the obligation to charge new and existing customers the same rate by giving new customers a cash incentive.
In the example above, Bank of Ireland would get little new business as their mortgage rates are so much higher than AIB. They can only get new business by offering 3% cash back. This would allow them to effectively offer new customers lower rates than existing customers.
So limiting cash incentives is an essential part of obliging lenders to charge the same rates to new and existing customers.
All variable mortgage rates should move up and down in line with the market and not just for some customers
When taking out a mortgage, a customer of KBC, for example, would expect that their rates would rise and fall in line with the market. Many chose variable rates instead of fixed rates because they expected rates in general to fall. They would not have chosen KBC if they had realised that they would not reduce rates in line with the market.
But we have no such controls or limits in any other industry! Why should we make an exception for the mortgage industry?
The mortgage market is different from every other market. The primary difference is the number of barriers to switching. If your phone provider increases the prices for existing customers, those customers can switch to another provider easily.
There are huge barriers to switching which are unique to the mortgage market
· The costs of switching mortgage are high – there is no cost to switching electricity supplier
· It is time consuming to switch provider – switching phone supplier is easy
· A customer needs a solicitor to switch mortgage providers – there is no cost to switching current accounts
· A borrower can’t switch if they have a bad credit record – Utility suppliers don’t check credit records
· A borrower can’t switch mortgages if their income or family circumstances have changed and they no longer meet the affordability criteria – suppliers of house insurance do not check a new customer’s affordability
There are other differences between the mortgage and other markets
· The Consumer Protection Code obliges lenders to treat customers fairly – there is no such obligation on utility providers.
· Mortgage payments are usually much larger than any other payment such as phone or electricity
· It is more difficult for ordinary consumers to understand and compare mortgage deals. Many people simply do not understand percentages. They are unable to incorporate 2% cash back into their mortgage decision. Gas prices are much easier to understand.
· When comparisons are difficult, the borrower will often default to the bank with whom they have their current account. So AIB and Bank of Ireland have almost a captive audience. There is no such tie-in with other industries.
· Most other industries pass on price increases and reductions to new and existing customers equally.
There are price restrictions in other industries
· Health insurers must offer any new product to existing customers
· Health insurers are not allowed discriminate on the basis of health. This is like telling mortgage providers that they must take on customers with bad credit records.
· We are gradually bringing in rent controls
· Some suppliers must seek government approval for price increases – An Post, Bus Eireann, credit unions, money lenders,
For most mortgage holders, their mortgage payments are much more important issues to them.
Lenders could be allowed to use very limited incentives as they use in other industries
They could be allowed to offer new customers and existing the customers the same rate, except for a reduction of up to 0.5% for up to the first 12 months. This would make the incentives comparable to other industries e.g. Virgin gives €30 off for the first 6 months and Energeia gives new customers 18% off for the first twelve months.
Wouldn’t such a restriction impede product innovation and differentiation?
Not at all. It’s just that they would have to offer their innovative and differentiated products to existing as well as new customers.
Health insurers are obliged to offer all new products to existing customers.
Would it not result in an increase in the rates for new customers?
It should result in fair rates for all customers.
At the moment even customers who are willing and able to switch get little benefit from switching because the lowest rate is 3%, well above where it should be.
A competitive market would lower this rate for all borrowers.
Would an existing customer get the rate for their current LTV or their original LTV?
There are arguments for both approaches.
The simplest would be to oblige lenders to offer the rate based on the original LTV but the mortgage offer should make this clear. “We are offering you the rate based on your LTV of 65% which falls into the category of 60% to 80%. If you reduce the LTV below 60% you will not qualify for the LTV rate appropriate to that category.”
How would this apply to fixed rates?
Lenders would be obliged to offer the same fixed rates to new and existing customers.
Some protection would need to be in place for those who do not want to fix but who can’t switch.
A lender could get around the rules by offering competitive fixed rates to attract new business, but keeping variable rates artificially high.
But if a borrower can avail of the same fixed rates as new customers, then this doesn’t matter.
It should also be absolutely clear to fixed rate customers what rate they roll over to on expiry of the fixed rate term.
But the Central Bank is addressing the problem by requiring lenders to be transparent about how they determine mortgage rates.
From the 1 February the [broken link removed] will apply
“Lenders will be required to produce and publish a summary statement of their policy for setting each variable interest rate that must include the factors that impact on the calculation of their variable rate and their criteria and procedures applicable to the setting of rates. If the lender applies a different approach to setting the variable interest rate for different cohorts of borrowers the summary statement must state that and must give the reasons for the different approach.
This summary statement will be provided to borrowers when they are offered a variable rate mortgage and also made available on the lender’s website on an on-going basis. Lenders will be required to notify affected borrowers of changes to the statement and make available an updated summary statement on their website.”
If this obliges lenders to be very specific to enable borrowers to distinguish between the different lenders, then it might help. But if they comply with it by making vague statements about market conditions, then it will be no help.
It would be better to simply oblige lenders to offer existing customers the same rates as new customers.
Obliging lenders to offer new rates to existing customers and prohibiting cash incentives will not solve all the problems
It will not solve the following problems
· Customers of lenders who are no longer active in the market who cannot switch will not benefit
· Customers with LTVs over 90% will not benefit
· Most customers will simply not bother to shop around when taking out a mortgage
· Most borrowers won’t be bothered to switch
Note: This is a long post!
Introduction
Imagine a market where lenders are obliged to pass on rate cuts equally to new and existing customers and where incentives for new business are prohibited. If a lender wants to compete for new business by cutting the rate for <80% LTV mortgages, they would have to cut the rate for their existing book of <80% LTV mortgages.
It would be much easier for the borrower to make an informed choice. They would be presented with something like the following information
KBC is clearly the cheapest lender, unless the borrower is borrowing over €200k and less than 80% LTV.
Bank of Ireland will only get business from customers who don’t shop around. So what will happen is that Bank of Ireland will be forced to compete by cutting rates.
Any customer who is prepared to shop around, will be able to see very quickly where the best deal is for them.
Over time, another lender may become cheaper than KBC. But a borrower will not find themselves taking out a mortgage with KBC, only to find KBC cutting rates for new customers only.
If one is relying on competition alone to solve the problem, then obliging lenders to offer existing customers the rates available to new customers is essential. Otherwise, most existing customers will not benefit from any increase in competition.
It is very important that the lenders are obliged to charge new and existing customers the same rates. If not, KBC may cut the rates for new customers only. Existing customers would not benefit from competition. Of course, those who could switch, might switch. But many can’t switch, and even for those who can, it’s time consuming and expensive.
Limiting cash incentives to the cost of switching is essential is we are to rely on competition
A lender could get around the obligation to charge new and existing customers the same rate by giving new customers a cash incentive.
In the example above, Bank of Ireland would get little new business as their mortgage rates are so much higher than AIB. They can only get new business by offering 3% cash back. This would allow them to effectively offer new customers lower rates than existing customers.
So limiting cash incentives is an essential part of obliging lenders to charge the same rates to new and existing customers.
All variable mortgage rates should move up and down in line with the market and not just for some customers
When taking out a mortgage, a customer of KBC, for example, would expect that their rates would rise and fall in line with the market. Many chose variable rates instead of fixed rates because they expected rates in general to fall. They would not have chosen KBC if they had realised that they would not reduce rates in line with the market.
But we have no such controls or limits in any other industry! Why should we make an exception for the mortgage industry?
The mortgage market is different from every other market. The primary difference is the number of barriers to switching. If your phone provider increases the prices for existing customers, those customers can switch to another provider easily.
There are huge barriers to switching which are unique to the mortgage market
· The costs of switching mortgage are high – there is no cost to switching electricity supplier
· It is time consuming to switch provider – switching phone supplier is easy
· A customer needs a solicitor to switch mortgage providers – there is no cost to switching current accounts
· A borrower can’t switch if they have a bad credit record – Utility suppliers don’t check credit records
· A borrower can’t switch mortgages if their income or family circumstances have changed and they no longer meet the affordability criteria – suppliers of house insurance do not check a new customer’s affordability
There are other differences between the mortgage and other markets
· The Consumer Protection Code obliges lenders to treat customers fairly – there is no such obligation on utility providers.
· Mortgage payments are usually much larger than any other payment such as phone or electricity
· It is more difficult for ordinary consumers to understand and compare mortgage deals. Many people simply do not understand percentages. They are unable to incorporate 2% cash back into their mortgage decision. Gas prices are much easier to understand.
· When comparisons are difficult, the borrower will often default to the bank with whom they have their current account. So AIB and Bank of Ireland have almost a captive audience. There is no such tie-in with other industries.
· Most other industries pass on price increases and reductions to new and existing customers equally.
There are price restrictions in other industries
· Health insurers must offer any new product to existing customers
· Health insurers are not allowed discriminate on the basis of health. This is like telling mortgage providers that they must take on customers with bad credit records.
· We are gradually bringing in rent controls
· Some suppliers must seek government approval for price increases – An Post, Bus Eireann, credit unions, money lenders,
For most mortgage holders, their mortgage payments are much more important issues to them.
Lenders could be allowed to use very limited incentives as they use in other industries
They could be allowed to offer new customers and existing the customers the same rate, except for a reduction of up to 0.5% for up to the first 12 months. This would make the incentives comparable to other industries e.g. Virgin gives €30 off for the first 6 months and Energeia gives new customers 18% off for the first twelve months.
Wouldn’t such a restriction impede product innovation and differentiation?
Not at all. It’s just that they would have to offer their innovative and differentiated products to existing as well as new customers.
Health insurers are obliged to offer all new products to existing customers.
Would it not result in an increase in the rates for new customers?
It should result in fair rates for all customers.
At the moment even customers who are willing and able to switch get little benefit from switching because the lowest rate is 3%, well above where it should be.
A competitive market would lower this rate for all borrowers.
Would an existing customer get the rate for their current LTV or their original LTV?
There are arguments for both approaches.
The simplest would be to oblige lenders to offer the rate based on the original LTV but the mortgage offer should make this clear. “We are offering you the rate based on your LTV of 65% which falls into the category of 60% to 80%. If you reduce the LTV below 60% you will not qualify for the LTV rate appropriate to that category.”
How would this apply to fixed rates?
Lenders would be obliged to offer the same fixed rates to new and existing customers.
Some protection would need to be in place for those who do not want to fix but who can’t switch.
A lender could get around the rules by offering competitive fixed rates to attract new business, but keeping variable rates artificially high.
But if a borrower can avail of the same fixed rates as new customers, then this doesn’t matter.
It should also be absolutely clear to fixed rate customers what rate they roll over to on expiry of the fixed rate term.
But the Central Bank is addressing the problem by requiring lenders to be transparent about how they determine mortgage rates.
From the 1 February the [broken link removed] will apply
“Lenders will be required to produce and publish a summary statement of their policy for setting each variable interest rate that must include the factors that impact on the calculation of their variable rate and their criteria and procedures applicable to the setting of rates. If the lender applies a different approach to setting the variable interest rate for different cohorts of borrowers the summary statement must state that and must give the reasons for the different approach.
This summary statement will be provided to borrowers when they are offered a variable rate mortgage and also made available on the lender’s website on an on-going basis. Lenders will be required to notify affected borrowers of changes to the statement and make available an updated summary statement on their website.”
If this obliges lenders to be very specific to enable borrowers to distinguish between the different lenders, then it might help. But if they comply with it by making vague statements about market conditions, then it will be no help.
It would be better to simply oblige lenders to offer existing customers the same rates as new customers.
Obliging lenders to offer new rates to existing customers and prohibiting cash incentives will not solve all the problems
It will not solve the following problems
· Customers of lenders who are no longer active in the market who cannot switch will not benefit
· Customers with LTVs over 90% will not benefit
· Most customers will simply not bother to shop around when taking out a mortgage
· Most borrowers won’t be bothered to switch
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