The Banks’ Gross Profits On Mortgage Holidays

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It does need to be pondered over, just where does The Times get these stories from? For here they’re claiming that mortgage holidays are going to produce bumper – hundreds of millions of quid – profits for the banks. Which isn’t quite, as we all should know, how banking works.

The £821m cost of our mortgage holidays
Lenders stand to make huge profits as unpaid home loans accrue interest

So how is this all calculated?

The mortgage breaks taken by 1.6 million homeowners could cost them at least £821 million in extra interest.

A borrower on the typical deal will save £2,256 in repayments by taking a three-month mortgage payment holiday. However, they will ultimately pay £500 more than they would have done without the break because of the interest accrued on the unpaid sum. This extra interest all finds its way to the banks.

The figures, calculated by the broker L&C Mortgages

Oh, OK, so they’ve been suckered by the PR department of some company. And failed to think through what they’re being told.

Because the assumption is – it’s right there, they’re saying it – that this extra interest becomes profit to the banks.

Ah, wait a minute. OK, so you take a mortgage holiday. You don’t pay for three months, OK, that’s fine, but you do have to pay that capital back at some point. Otherwise you’d never pay off your mortgage, would you? And, presumably, and this is what has been presumed, you’ll pay off your mortgage three months later than you would have done without the holiday. This means you’ll be paying interest on the outstanding part of your mortgage for longer then which is where that extra interest to be paid comes from.

So, the amount extra to be paid in interest is fine. Sure, it’s an average and makes some assumptions but that’s all fair enough.

It’s the idea that this will all flow through into bank profits which is so silly. For banks don’t lend out their own money at interest. Banks borrow money, paying interest upon it, then lend that money out and charge interest upon it. They might borrow from our checking accounts – this is known as the float – they might borrow from another bank in the overnight market, they could today at least borrow from the Bank of England, they might borrow from our savings accounts, they could issue bonds….the important thing about all of these sources of money being that the banks have to pay interest to get hold of that money. OK, on our current accounts it’s an entirely nominal sum normally which is offset against the costs of allowing us to use cheques etc but still. They carry costs for getting access to that money they then lend out.

So, sure, mortgage holidays mean more interest to be paid to the banks. The banks have to borrow exactly the sum – or borrow it for longer, whatever – that is deferred in those mortgage holidays and pay interest for doing so.

That is, the interest paid to the banks is not profit. It’s not even gross profit. The extra interest received minus extra interest paid could be regarded as one measure of gross profit. And the net profit will be that minus the costs of doing the doing. Which, given that the usual calculation is that it costs a bank £25 to send you a letter is going to be high. Or low perhaps, depending upon whether we’re talking about the costs of doing the doing or the amount left over after the done has been done.

It could be that the banks will make a loss on these mortgage holidays. It could be that they’ll make a gross profit but an overall loss. They might even make a profit as well as a gross profit. But absolutely none of those figures are going to be equal to the extra interest received as a result of the mortgage holidays.

‘Tis a pity the newspaper of record says they will be, eh?

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Spike
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Spike

Well-spotted! And, beyond obtaining the merchandise (the capital) that is to be given away, and the $25 cost of sending each homeowner a letter (only one?), there is the cost of reprogramming the lender’s systems for a one-time change to the terms of every mortgage. A business has costs, and a politician waving his hand and proclaiming a payment holiday gives them additional costs, notably: learning about the new rule, complying with it, and assembling proof of compliance.

John B
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John B

Perhaps banks should be given a deposit interest holiday, and the credit cards should have a giving-credit holiday. Perhaps this might go some way to penetrating the thick heads who think lockdown is AOK really and just paid holiday.

john77
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john77

Good article! The banks will use as much interest-free float from our current accounts as they can *but* – of course – they are already doing so. Therefore the extra cash that they need to borrow in order to defer interest (and capital re-) payments will cost them interest, presumably at LIBOR (currently 0.55%, so between one fifth and one-quarter of the average mortgage interest rate). Secondly the losses on any default will be greater by the amount not received during the mortgage holiday – and the defaults will be greater because the economic circumstances that cause 100 cutomers to… Read more »

Phoenix44
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Phoenix44

More to the point, won’t the extra cash come at the end of the mortgage period, say an average of 12 years away? Which means the PV is not very much at all?

Barks
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Barks

Somewhere, be it journo school, staff meetings or the favored pub, media writers are taught to disregard the difference between revenue and profit. All but the most serious financial writers routinely confuse, conflate and corrupt information concerning revenue and profit. This is a worldwide phenomenon.

Spike
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Spike

The phenomenon is more general than this, as Tim routinely observes that they don’t know the difference between any figure and the rate-of-change of that figure. Perhaps what they are taught is to disregard the difference between anything and anything else. Culminating in a President who thinks a current-account deficit means a nation is “stealing from us.”

Bongo
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Bongo

If this was a profitable play for the banks, why do they have to be nudged into providing the holidays? It doesn’t make sense.

Jim
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Jim

” Banks borrow money, paying interest upon it, then lend that money out and charge interest upon it. ” Really??? Have you seen the difference between savings rates and borrowing rates at the moment (and indeed for the last decade)? The banks have been paying peanuts for money and charging whatever is the going rate. Their profit on lending is virtually the entire interest coupon. My bank just sent me a letter telling me my money on deposit was going to accrue at the wonderful rate of 0.05%. Yet if I wanted a mortgage the same bank would want to… Read more »

Spike
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Spike

You’re kidding: You say the asking price for capital is higher than the bid price? That’s got to be unfair!

No, on second thought, that is how banks make a profit, isn’t it?

While a pittance, it IS “wonderful” that your bank feels bound to pay you some interest for your deposits, given that most of our nations are toying with zero and negative interest rates.

Jim
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Jim

” You say the asking price for capital is higher than the bid price? That’s got to be unfair!” Of course not, where did I say that? All I’m saying is that they are getting their raw material for virtually free, and charging it out at well above the BoE base rate. Its a licence to print money, or profits at least. The banks are in such a powerful position, they can effectively (as a collective) pay as little as they like for deposits and charge as much as they like for loans. There’s tens of millions of depositors and… Read more »

Spike
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Spike

I did not quote you and thus did not misquote you. You did express disgust that 3% is higher (okay, too much higher) than 0.05%. Now you carp that the banks have “far too much market power” – though you would go FURTHER toward cartel, dictating both their prices and their profit.

Any bank that thinks the current spread is too wide is able to offer more attractive terms; and nominally, anyone is free to open a brand-new bank, though who’d want to?

Jim
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Jim

“nominally, anyone is free to open a brand-new bank, though who’d want to?”

Exactly, nominally. Its hardly the easiest market to enter is it, banking? Its totally protected by the State regulating who can compete.

And a cartel is not when the State regulates an industry, its when an industry regulates itself, ie fixes prices so all the cartel members win at the expense of the customer. Which is effectively what you have in banking – there’s certainly zero competition for deposits. I wonder why that might be?

Quentin Vole
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Quentin Vole

I’ve got a wonderful idea for a new business. Hand out mortgages and then declare a permanent interest holiday. I’ll be rich … rich, I tells ya!