Why are banks giving mortgages for 5% when they could invest that money in gilts for 5.1%?

Answer 1

because they are nice

Answer 2

First of all, let's get the facts straight. A quick look at Bloomberg's interest rates page for the UK:

http://www.bloomberg.com/markets/rates/uk.html

shows that 5% yield to maturity can be had only in gilts with durations shorter than three years. 20-year gilts yield 4.35%, 30-year gilts, 4.05%. So a 30-year mortgage underwritten at 5% will carry a 0.95% yield premium over a 30-year gilt. Additionally, 5% is not the market average, but rather the lower edge of the band, the high edge being closer to 6%:

http://moneycentral.moneyextra.com/compare/mortgages/msn/Illustration.jsp;jsessionid=tFcMJg8jaYIvx5gwDDUGAA**.mst2?token=bc21f48a8827cd622f53f7c260f2dca9
http://moneycentral.moneyextra.com/compare/mortgages/msn/Illustration.jsp;jsessionid=tFcMJg8jaYIvx5gwDDUGAA**.mst2?token=e51fefa428ddb5a518303ee74666698f

Also, in the UK, fixed-rate mortgages are somewhat of a misnomer. Fixed rate only applies during the specified initial period (which could be as short as two years and as long as 20 years), after which it may revert to a higher rate.

Then, mortgages, unlike gilts, pay fees. A typical closing fee may be as high as 0.5% of the mortgage, payable upfront. Also, in the UK, it is legal to charge prepayment penalties on home mortgages, which many banks do.

Finally, duration. A 30-year mortgage has a much shorter duration compared to a 30-year gilt...

Answer 3

I am assuming you are speaking of British banks. The reason I would suspect is duration, if so. A 30 year mortgage and a 30 bond have different durations even though they would mature at the same time. This is due to the fact that principal would be repaid and so cash flows are accelerated. It also implies that the market considers there to be little to no difference in credit quality between government and mortgage debt.

Answer 4

First of all, let me give you the latest rates that I checked from Bloomberg; 15-year US mortgage 5.57%, 30-year US mortgage 5.86%, 30-year US bond 4.79%, 15-year gilt 4.51%, 30-year gilt 4.05%.
According to these figures, mortgages are more profitable. You should also take into account that mortgages bring some commission and fee income to the banks. Please also note that the rates should be compared with their maturities and the currencies they are based on.