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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.
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.
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.
A 2-year swap rate is the average expectation of interest rates over the next two years
A 5-year swap rate is the average expectation of interest rates over the next five years.
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.
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.
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).
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 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.