When the Bank of England changes Bank Rate, borrowers often expect mortgage rates to move immediately in the same direction.
Tracker and variable mortgage rates may respond relatively quickly, depending on their terms. Fixed mortgage rates can behave very differently.
A lender may reduce fixed rates before Bank Rate falls, increase them while Bank Rate remains unchanged or withdraw products after financial markets react to new economic information.
To understand why, borrowers need to distinguish between Bank Rate, swap rates and the many other costs involved in pricing a mortgage.
What is Bank Rate?
Bank Rate is set by the Bank of England’s Monetary Policy Committee.
It influences the cost of borrowing throughout the economy and can affect mortgages, savings, business finance and other lending.
A tracker mortgage normally follows Bank Rate or another specified benchmark plus a margin set by the lender. If the tracked rate changes, the mortgage rate and payment may also change in accordance with the product terms.
A lender’s standard variable rate may also be influenced by Bank Rate, but it does not necessarily move by the same amount or at the same time. The lender normally controls that rate, subject to the mortgage conditions.
Fixed mortgage rates are not linked directly to each Bank Rate decision in the same way.
What are swap rates?
Swap rates are market rates used by financial institutions when managing the risk associated with lending money at fixed interest rates.
In simplified terms, they indicate the cost of securing fixed-rate funding over different periods. Two-year and five-year swap rates are therefore often relevant when lenders price mortgages fixed for similar periods.
Swap rates reflect financial-market expectations about future interest rates, inflation and economic conditions.
These expectations can change daily as new information emerges, including:
- Inflation figures.
- Wage growth.
- Employment data.
- Economic growth.
- Government borrowing.
- International financial developments.
- Statements from central banks.
- Changes in market confidence.
A swap rate is not a guaranteed forecast of where Bank Rate will be. It represents market pricing at that moment and can move rapidly when expectations change.
Why might fixed mortgage rates fall before Bank Rate?
If financial markets become more confident that inflation is easing and future Bank Rate reductions are likely, swap rates may fall.
That can reduce part of the lender’s cost of offering a fixed-rate mortgage. A lender may then reduce its rates before the Bank of England makes any change.
By the time Bank Rate is eventually reduced, financial markets may already have anticipated that decision. Fixed mortgage rates might therefore change very little on the announcement date.
This explains why waiting for a widely expected Bank Rate cut does not guarantee that a better fixed mortgage will become available immediately afterwards.
The expected reduction may already be reflected in mortgage pricing.
Why might mortgage rates rise when Bank Rate is unchanged?
The reverse can also happen.
Stronger inflation, unexpected economic data or changing expectations about future interest rates can push swap rates higher even though Bank Rate has not moved.
Lenders may then increase fixed mortgage rates, reduce the period for which a product remains available or withdraw it completely.
Borrowers can understandably find this confusing. The Bank of England may have announced no change, but the market’s expectations about the coming months or years may have altered substantially.
Fixed mortgage pricing responds to those expectations as well as the current Bank Rate.
Swap rates are only part of the price
A lender does not simply take the relevant swap rate and add a fixed profit margin.
Mortgage pricing can also reflect:
- The lender’s funding arrangements.
- Operational and administration costs.
- Credit and property risk.
- Regulatory capital requirements.
- Loan-to-value.
- Expected business volumes.
- Competition from other lenders.
- The borrower and property type.
- Arrangement fees and incentives.
- The lender’s appetite for new applications.
Competition can be particularly important.
A lender seeking more business may reduce rates or introduce attractive products. Another lender receiving more applications than it can process may increase rates or withdraw products to control demand.
Two lenders facing similar market conditions can therefore price their mortgages differently.
Why do mortgage products sometimes disappear quickly?
Mortgage products are not guaranteed to remain available.
A lender may withdraw a rate when its funding allocation has been used, market pricing changes or application volumes exceed operational capacity.
The replacement product may have a higher rate, different fee or altered lending criteria.
Borrowers should not be rushed into an unsuitable mortgage, but they should understand that an illustration obtained today does not reserve the product indefinitely.
An application normally needs to be submitted correctly, with the required information, before the lender can secure the chosen product. Even then, the case remains subject to underwriting, valuation and the lender’s terms.
What does this mean for landlords?
For landlords, mortgage pricing affects more than the monthly payment.
The interest rate can influence the lender’s rental stress calculation and therefore the maximum mortgage available.
A higher rate may mean:
- The property needs to produce more rent.
- The landlord requires a larger deposit.
- Less equity can be released.
- A proposed purchase no longer meets the lender’s calculation.
- A different product or lender must be considered.
Portfolio landlords should also examine the combined effect of rate changes across several properties. Multiple mortgages reaching the end of their initial deals within a short period can place considerable pressure on cash flow.
Maintaining a finance calendar and beginning each review three to six months before expiry can provide more time to compare the options.
Should borrowers wait for rates to fall?
Waiting can be a deliberate decision, but it is not risk-free.
Rates may fall, remain unchanged or increase. The preferred product may be withdrawn, while delays could affect a purchase, remortgage or the date on which an existing mortgage moves to a reversion rate.
Rather than attempting to predict the market perfectly, borrowers should consider:
- When the funds or mortgage offer are required.
- What payment is affordable now.
- How a higher rate would affect the figures.
- Whether the product permits changes before completion.
- The cost of remaining on the current mortgage.
- The consequences if the expected rate reduction does not happen.
Some lenders may allow an applicant to move to a lower product before completion, but policies and procedures differ. This possibility should be checked rather than assumed.
Look beyond the headline rate
Bank Rate and swap rates help explain the direction of mortgage pricing, but neither tells an individual borrower which mortgage is suitable.
The complete comparison should include the interest rate, arrangement fee, incentives, early repayment charges, flexibility and total cost over the intended product period.
NetRent Mortgage Solutions works with DNA Financial Solutions to help landlords, homeowners and other borrowers understand current mortgage and remortgage options.
To discuss an approaching remortgage or proposed purchase, contact NetRent:
Telephone: 01352 721300
Email: mortgages@netrent.co.uk
NetRent does not provide legal or tax advice. This article represents our general understanding of the mortgage and rental property market and is provided for information only.
Mortgage products, rates, fees and lender criteria can change. Individual circumstances vary, and appropriate mortgage and financial advice should be obtained before proceeding.