With inflation largely tamed, the Bank of England (BoE) cut interest rates from 5.25% to 5% on 1 August, marking the first cut since March 2020. These official rates have an effect on lenders setting interest rates for borrowers. Future BoE decisions are uncertain, but many forecasts include an extended rate-cutting cycle that may last into 2026.
This article explains why it is crucial to monitor rates if your mortgage is coming up for renewal and/or you have accepted a mortgage offer, but your new deal or interest rate hasn’t started yet.
How do banks set rates?
Banks and other lenders earn an interest rate difference between loans and deposits such as savings accounts. Money deposited on savings accounts is typically not sufficient for banks to meet mortgage and other loan demands, but other funding mechanisms are available. Banks themselves can borrow money from other financial institutions, with the interest cost being determined by the ‘swap rate’.
What are swap rates?
Swap rates are based on interest rate expectations by professional market participants. For instance, a five-year swap rate is the average expectation of interest rates over the next five years. Decreasing swap rates mean that lenders’ borrowing costs less, and a portion of this is typically passed on to borrowers through lower mortgage interest rates. In short, swap rates and mortgages tend to move in tandem, although lenders update their mortgage rates infrequently, while swap rates see daily changes.
The importance of monitoring rates
Mortgage costs are currently high, but many market participants expect that interest rates will fall in the months/years to come. The following example scenario highlights how rate monitoring can pay off when swap/mortgage rates are falling. In this scenario, the borrower applies for a £450,000 interest-only mortgage. The interest rate changes five times – from an initial 5.74% at the point of offer from the lender (application), to finally locking in at 4.08% months later, ahead of the start of the new deal (completion).
This lower rate is maintained, despite the fact that rates rise after this point. The borrower achieves savings of £37,000 over the five-year term, due to rate monitoring.
Sourcing a new deal
Choosing the mortgage type (fixed versus variable) or the length of a fixed-rate period can be daunting, but a mortgage adviser can help you by highlighting all-in-costs, and the advantages and drawbacks of different products. Tracker mortgages may become a more appealing option for borrowers who can handle uncertain interest payments and expect significant decreases in the BoE rate. Large sums can often be saved by switching from your existing lender to a new one when remortgaging.
Plan six months ahead
You can normally lock in a rate up to six months before the deal starts. Securing a rate well in advance is good practice, in case the market changes and rates go up. A good mortgage broker will still switch you over to a cheaper deal before completion if the initial rate falls in the meantime. In some cases, as the example scenario highlights, you can be switched onto a cheaper deal multiple times. For more on the benefits of rate monitoring, click here to listen to our Financial Illumination podcast episode.
Sign up to our Mortgage Renewal Register and we’ll help you find the best available rate ahead of the end of your mortgage deal. Ongoing rate monitoring is included – if the rate improves after your initial offer, we’ll switch you over to the cheaper deal. Visit luminwealth.co.uk/renewal-register to sign up.
This article is for general information purposes only and does not constitute financial advice or a personal recommendation. Your home or property may be repossessed if you do not keep up repayments on your mortgage. Mortgage availability and terms depend on your individual circumstances and are subject to lender criteria.
