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What are swap rates and how do they impact mortgage rates?

June 27th, 2023 by

What are swap rates UK and how do they impact mortgage rates?

When it comes to securing a mortgage, understanding the various factors that influence interest rates is important. One such factor is Sterling Overnight Index Average (SONIA) swap rates. In the United Kingdom, SONIA swap rates play a significant role in determining mortgage rates for many borrowers and have been frequently mentioned in the news. In this article, we will delve into what swap rates are and their impact on mortgage rates.

What is an interest rate swap?

An interest rate swap involves a contractual arrangement between two parties, wherein they agree to swap one set of interest payments for another over a specific duration.

What are SONIA swap rates?

SONIA replaced London Interbank Offered Rate (LIBOR) in 2021 as the primary interest rate benchmark in sterling markets. For mortgage rates, lenders use swap rates to protect themselves from interest rate risks and allow lenders to hedge the risk by locking in margins. By ‘locking in’, lenders maintain their margins even if the cost of funds increase, for example, this could be an increase in the base rate. The period can be for a range of terms of 1, 2, 3, 5, 7, 10, 15 or 30 years. Not every bank will choose to hedge using swap rates, some may choose to hedge naturally using saving bonds.

Swap rates reflect market expectations of the future direction of Central Bank interest rates. They are based on the assumptions surrounding what interest rates are expected to be over the term of the swap rate. These assumptions consider factors like inflation, prices of food, fuel, and the general economy which all feed into these forecasts. This is also the rate at which lenders use when setting a price to borrow funds to assist with their own supply and demand.

2-year UK swap rates

A 2-year swap rate is the average expectation of interest rates over the next two years

5-year UK swap rates

A 5-year swap rate is the average expectation of interest rates over the next five years.

Why are swap rates so volatile at the moment?

Swaps have become volatile due to many factors including numerous rises in the base rate, inflation data, market uncertainty and sentiment, and the war in Ukraine to name a few.

The volatility in swap rates has been constant since the Bank of England has been increasing the base rate. This movement in swaps became particularly volatile following the mini-budget in September 2022 and swaps jumped significantly in a very short space of time.

How do swap rates impact mortgage rates?

Swap rates only influence fixed rate mortgages: The higher the swap rate, the higher the mortgage rate before risk and lending appetite are considered. Lenders often see swaps as their cost of funding, and so they need to make a margin on top of these.

Rapid movement in swaps can make it hard for lenders to price their products appropriately. This is why we have witnessed many lenders pulling products temporarily during periods of high swap rate volatility as lenders read the market and settle on their repricing.

Some lenders may also temporarily withdraw mortgage products if they find themselves offering too competitive of a rate against their competitors following swap rate rises. Potentially if they don’t increase their pricing, they may become inundated with applications and unable to cope with demand. Despite what the press writes, mortgage products being pulled isn’t as scary as it can seem. The key part here is that mortgage lenders are still willing to lend with plenty of money to allow for this, and although the base rate is at the highest since October 2008, this isn’t a repeat of the same conditions of 2008.

When will swap rates and mortgage rates activity calm down?

While we unfortunately do not have a crystal ball and cannot see into the future, until inflation is controlled and the base rate has peaked and starts to fall, it can be assumed that swap rates will continue to fluctuate. The base rate rose by 0.5% to 5% on the 22nd of June 2023, and the current forecast expects the base rate to average around 5.5% over the next three years (Bank of England).

What other factors impact mortgage rates?

It’s important to note that while swap rates serve as a reference point, lenders also consider other factors when determining mortgage rates. These factors include the Bank of England base rate, internal lender targets, service levels and competitor pricing, as well as many other factors.

Any increase to the base rate directly impacts tracker rates as these are directly linked to the Bank of England base rate. As the name suggests, monthly payments for those with a fixed rate mortgage will remain the same – these are not impacted by base rate movements during the fixed period. The full impact of the increase in the base rate to date will not be felt for some time, until needing to remortgage.

Swap rates and your mortgage

Swap rates in the UK play a crucial role in determining mortgage rates. By understanding swap rates and their impact on mortgage rates, this can help navigate the mortgage market more effectively and make informed decisions. We understand mortgage pricing is not so straightforward and can be quite tricky to get your head around. We are on hand if you have a question about mortgage pricing and how the financial market impacts your mortgage. We continue to monitor the mortgage and wider financial market to observe if any changes may impact our clients.

If your remortgage is due in the next six months, Private Finance can secure your mortgage offer now and lock in a mortgage rate, providing more peace of mind if rates rise further. This offers flexibility to continue to monitor rate movements over July and respond if conditions change.

Please remember that your home may be repossessed if you do not keep up repayments on your mortgage.

The May 2015 General Election and your mortgage

October 1st, 2015 by

Are you thinking of buying a property or remortgaging to fix your rate, release capital or reduce your monthly repayments? Our advice is not to let the forthcoming General Election, already set for 7 May 2015, delay your decision. Interest rates can go only one way, upwards, and, according to the mortgage market, there is a possibility that they may do so before next May.

Two year fixed rates below 2%, five year fixed rates below 3%

The latest Moneyfacts UK Mortgage Trends report shows that the average two-year fixed rate mortgage fell by a 0.13% last month to just 3.39%. If you have significant equity in your home or a sizeable deposit, the lowest two-year fixed deal on the market offers borrowers with a 40% deposit the chance to secure a mortgage at a rate of just 1.49% (details here). The best 5 year fixed rate at the same loan to value ratio would cost 2.59% (details here).

Competition for your business

Mortgage lenders are currently offering the best deals you are likely to see for some time, if ever again.  Some of this is to do with having to hit lending targets by the end of the year and needing to offer attractive rates to make sure that sufficient mortgages complete before Christmas. Another factor is the imminent rise in the Bank of England Bank Rate (also known as the ‘base rate’).

Current homeowners who already have a mortgage are likely to be on a good rate. Many are on their lenders’ standard variable rate (SVR) – the rate that mortgages tend to revert to after their initial deal period (e.g. 2 year fixed rate) comes to an end. These also are at historic lows, which means that customers have little incentive to search for a better deal as they are already enjoying a great rate where they are. But, that will all change when the base rate rises. Lenders’ variable rates will increase and customers on SVR will be able to leave without any early repayment fees that would have been due during a fixed rate period.

So mortgage lenders are having to offer very competitive rates currently because they do not want to risk losing their existing customers when the base rate rises and they start to look around the wider market for a better deal. By cutting their rates so dramatically, they are already standing out from the crowd and will appeal to both new home buyers and remortgagers alike.

When will rates rise? Possibly before the May 2015 General Election

  • Howard Archer, at IHS Global Insight, forecasts a rise in February 2015 and says: ‘furthermore, it now looks far from inconceivable that the Bank of England could act before the end of 2014’
  • The CEBR forecasts an early 2015 rise
  • Capital Economics forecasts an early 2015 rate rise
  • The IMF suggests an early to mid-2015 rise for the UK

Next Steps

These low rates won’t be around forever, and when the base rate does rise mortgage rates will quickly follow. Enquire about these low rates now, whether you’re thinking about buying or are starting to think about remortgaging to a fixed deal that will give you peace of mind from any interest rate shocks.

Private Finance

Private Finance provides first-class independent mortgage advice to suit your requirements.

Founded in 1999, it has established relationships with the key lenders in the UK mortgage market, including those who do not have a high-street presence. It arranges bespoke mortgage solutions for its clients. It works quickly and efficiently on your behalf, leaving you free to get on with your life. Its service is individual; the latest technology is used without compromising its commitment to personal service.

Whether you are acquiring a property or looking to remortgage an apartment or a house, Private Finance can help. Specialising in the arrangement of larger property loans, its experienced mortgage finance professionals have access to the whole of the market and provide a tailored one-to-one advisory service, delivered face-to-face or remotely to fit your circumstances, allowing you to finance your property in a convenient and stress-free manner.

Email or call 0800 980 8777.

Private Finance