Are mortgage rates cheaper now the base rate dropped?

We’ve been asked this question a great deal recently and so thought it important to clarify how the Bank of England base rate relates to actual fixed rate mortgages. This is an infinitely complex subject with many layers and systems that are well beyond my full understanding. I don’t have a degree in economics nor practice economics at any meaningful level. However there are two simple mechanisms that most people understand that we can use to illustrate the broad concept:

Futures and Gilts

Futures

Futures are a method of hedging against price fluctuations. A great example is wheat flour used to make bread. A large bakery making millions of loaves of bread don’t want to be adjusting prices day to day to reflect the price of the flour used to make them. It would be an administration nightmare and supermarkets and buyers would complain. So futures traders sell flour to bakeries over a period of time, using their data and algorithms to give a price to bakeries that’s stable whilst still carving out a profit for themselves. They essentially take on that risk for a small price.

The exact same process, although far more complex and varied, happens with financial products. If a lender is giving you money and expects it to be repaid over 5 years (granted the total term is longer, but you are tied in or committed for that 5 years) then there’s a real risk that if things change they could be out a lot of money. To make it easier to price mortgages and focus on their core objective, selling mortgage loans, they use the swap market, just like wheat flour futures traders they agree a price for a tranche of money with another financial intermediary and essentially hedge this risk for a small price.

There is a nationwide tracker for all of these rates, the SONIA swap rate, an aggregate of all these trades and this indicates what will happen to mortgage rates in the near future. Whilst this does bear a resemblance to the Bank of England base rate and it is indirectly related, its not the same and there are other things that influence it.

Gilts

Gilts are on of a number of ways to generate an income from a lump sum of money. If you have a pension a proportion of the funds will be invested in Gilts. They are provided by the UK government. The government primarily generates income through taxes but also borrows funds by issuing bonds. A bond is a commitment to repay money in the future with regular interest payments. UK government bonds, known as gilts, are considered very safe investments because the government is highly likely to repay them. These bonds are mainly purchased by financial institutions in the UK and abroad, such as pension funds, investment funds, banks, and insurance companies.

Following the recent budget, there was some anxiety as interest rates, or gilt yields, began to rise. The yield is the interest rate the government must pay to its lenders. An increase in yield indicates that investors perceive lending to the government as riskier. This is significant because it means the government will incur higher borrowing costs, and bond yields also influence the rates on loans and mortgages.

Taking the two factors above gives us a better idea of how mortgage rates in the UK are linked to the Bank of England Base rate.

The base rate influences the yields on guilts, this and the wider predictions on where economic growth, inflation and all those factors influences swap rate providers, which in turn influences the rates you see available for 2 year and 5 year mortgages.

So why have mortgage rates gone up when the Bank of England rates have gone down?

The simple answer is that the base rate drop we saw recently was widely expected, so swap providers had already factored this into their rate. However, alongside the reduction in Bank of England base rate, the prediction of when the next base rate drop will occur has been pushed back. The current rate will remain in place longer than was expected.

Conclusion

Unless you have the data and know how of a financial analyst its going to be very hard to predict what will happen, however looking at the SONIA swap rates and news relating to this instead of the Bank of England base rate alone will certainly provide a more clear picture of where things are heading. Ultimately mortgage rates will continue to fall, the real question is when and how fast.

We always welcome enquiries from those looking to better understand what all this means to their own mortgage costs. If you have committed to a higher mortgage rate now and are fixed into a deal, we also have some very clever tracking software that will monitor existing mortgage rates and tell you if its worth paying the Early Repayment Charge in order to save on monthly repayments, and how much you will save altogether. If you have any questions or would like a review, please do not hesitate to complete the “contact us” for on the right, or give us a call on 020 7183 1101