In a 60-page staff working paper, the UK’s central bank said borrowers appear slightly more sensitive to interest rates than to origination fees, especially younger households with lower incomes.
“Overall, the demand parameters suggest that borrowers may be shopping across lenders and across products for low interest rates focusing less on origination fees,” the bank concluded.
Mortgage lenders have been cutting their interest rates to record lows. Just last month, Nationwide became the first lender in British history to offer a sub-1 per cent rate on a five-year fixed rate mortgage. Two weeks later, Halifax undercut the rate.
The Bank of England’s data suggests the gap between mortgage lenders’ interest rates and their origination fees began to widen notably following the Funding for Lending Scheme (FLS).
Introduced in 2012, the scheme was designed to provide funds at cheaper rates to lenders and spur more household lending. The central bank said it boosted UK lending by more than 30 percent.
It also meant lenders decreased interest rates, but increased origination fees. The Bank of England’s data showed a £1,000 higher origination fee corresponds to a 27 basis points lower interest rate.
Conversely, a product with zero fees tends to be offered at an interest rate that is on average 33 basis points higher than an identical product type with fees.
Prior to FLS, the bank said these fees “were quite stable”, but increased by approximately £100 afterwards.
The paper also highlighted mortgages with fixed interest rates for a relatively short (e.g. two years) period “encourage borrowers to remortgage frequently and, as a result, generate large fee income for lenders”.
The Bank of England modelled a scenario where it banned lenders from charging any origination fees.
“In such a counterfactual scenario with zero origination fees, lenders charge higher interest rates to offset the drop in profits due to the ban on fees.
“Naturally, lenders’ profits decline but consumer surplus also decreases, indicating that they benefit from this market segmentation and price discrimination increases surplus.”
It concluded that “although origination fees allow lender[s] to price discriminate and capture surplus”, banning fees altogether “would lower borrower surplus and aggregate welfare”.