Speaking with a number of brokers, business development managers and clients recently, a pattern seems to be emerging that could result in some real frustration for mortgage customers in the coming months. There appears to be an assumption that mortgage rates are directly tied to Bank of England base rates, and that mortgage rates will only come down in the latter part of this year. That isn’t the case, and the reality is that if the Bank of England decide not to reduce the rate, rates could actually go up.
If you think about it, the fact is 5 year fixed rates are around 4% – 4.5%, whilst the Bank of England rate is 5.25%.
The reality of how lender mortgage rates are set is, like most financial services today, extremely complicated, and I wont pretend I’m an economist. However, there are a few things that should be known:
- The banks don’t lend you other peoples money. Having a banking license grants them the ability to simply create money from thin air as debt. They do however have to keep a certain amount of that debt as liquid funds
- Banks use futures trading much like other industries. As a large scale bread maker, you might want to secure your next 5 years supply of wheat at a certain price so you can prevent market volatility bankrupting you
- Not all lenders are banks, and source their funds from other parts of financial services, such as annuities who receive large sums and pay out regular amounts, or from private investment and the sale of “mortgage books”
However, most high street lenders are banks and when they are creating that debt they are mindful that all their calculations are based on a certain Bank of England base rate which can change, whereas their mortgage offer is fixed for 2, 3 or 5 years. Like the bread manufacturer they go out to what they call the swap market. They essentially pay a premium and insure themselves against what the Bank of England base rate might do.
Those swap rates are based on analysts and data, much like a stock broker will use their insight to predict who to invest in, and takes all the available information in hand. They want to be competitive and offer the best deal, without leaving themselves vulnerable. If you know about a Bank of England rate reduction, so do they, in fact they will likely be plugged into those networks and have access to far more detailed resources than consumers, journalists, mortgage brokers or possibly the banks themselves.
Take a look at the chart here on the 5 year swap rates, that is the average of all of the rates offered against the actual Bank of England base rate. You can clearly see that the swap rate anticipated a rise in rates and that now, whilst the Bank of England rate is stable, the swap rates are trending below. They are anticipating a drop in rates and the fluctuations are as a result of a changing prediction on whether the rate will indeed drop in the last quarter of this year.
The latest news, as of late July 2024 is that stubborn inflation figures and better than expected GDP figures might see the Bank of England delay the rate drop, and that will be reflected in a rise in the swap rates offered, and therefore an immediate rise in mortgage interest rates. Regardless though, the key takeaway from this is that rates are set based on what the market expects, not the actual Bank of England rate, and so there is absolutely no point in waiting for the Bank of England , and further, doing so might see you lose out on a lower rate because once the bank withdraws them, they wont be available. If you secure something now and mortgage rates do drop, you can always switch before you complete.
