A common question many people have is whether a drop in the Bank of England’s base rate will result in lower mortgage rates.

The short answer? Not necessarily.

The first point to note is that the impact is different whether you have a fixed or variable rate mortgage.

Fixed rate mortgages

The base rate and fixed mortgage rates aren’t directly connected. While the base rate reflects the cost of borrowing now, fixed rates are shaped by the expected cost of borrowing over a fixed period.

While the base rate can indirectly influence fixed mortgage rates through broader market trends, many other factors are involved in determining these rates.

Variable rate mortgages

Variable rate mortgages have interest rates that fluctuate in response to changes in economic or financial market conditions, unlike fixed-rate mortgages.

A tracker rate mortgage tied to the Bank of England base rate results in changes to your mortgage repayments if there are any changes in the base rate. We’ll explore other types of variable rate mortgages later in this article.

The base rate vs. mortgage rates: Clearing up the misconception

The base rate often makes the headlines, so it’s easy to assume it has a direct and instant effect on all types of mortgages. We’ll now go a little further into the key variables that impact fixed and variable rate mortgage pricing, and explore the different types of variable rate mortgages.

Key factors influencing fixed mortgage rates

Other factors that could impact mortgage rate pricing include, but is not limited to, Sterling Overnight Index Average (SONIA) swap rates, lender’s internal targets, competition amongst lenders, varying lender service levels, and other economic and market conditions.

SONIA swap rates

One of the primary factors affecting mortgage rates is the SONIA swap rates, which play a major role in determining fixed-rate mortgage pricing. SONIA swap rates are based on market expectations for future central bank interest rates over a specific term. For example, a 5-year swap rate is the average expectation of interest rates over the next 5 years. This term reflects assumptions about inflation and economic growth.

SONIA swap rates give lenders a level of predictability in setting mortgage rates. Lenders use these rates to manage risks associated with changes in interest rates, allowing them to maintain steady mortgage pricing even if the base rate fluctuates. For example, if swaps were to increase on average compared to last month’s swap rates, we could expect lenders to increase their fixed mortgage rates. More information on how swap rates influence mortgage pricing can be found here.

Lender’s internal targets and competitor pricing

Mortgage lenders operate within a competitive market, and their pricing often reflects both internal lending targets and competitor rates. To stay attractive to borrowers and to offer the best lending solution in the market at certain times, lenders frequently adjust their rates based on these goals, market positioning, and how competitive they can be considering the cost of funds.

Managing demand and service levels

The balance of demand within the lending market also influences mortgage rates. When demand for mortgages is high, lenders might adjust rates to regulate the volume of new borrowers so they can manage service levels. In times of lower demand, rates might be more favourable as lenders seek to attract new business and maintain existing clients.

Economic and market conditions

Broader economic factors, such as inflation rates, consumer confidence, and wage growth, also impact mortgage rates. For instance, rampant inflation may be perceived as high risk for financial markets, and consequently SONIA swaps and thus fixed mortgage rates may rise in line with cost of funds.

Key factors influencing variable mortgage rates

The interest rate on a variable rate mortgage can go up or down during the life of the loan, leading to potential adjustments in the borrower’s monthly mortgage payments.

There are three main types of variable rate mortgages: tracker rate mortgages, standard variable rate (SVR) mortgages, and discount rate mortgages.

Tracker rates linked to the base rate

Tracker rate mortgages, also known as variable rate trackers, that follow the Bank of England base rate, go up or down in line with the Bank of England base rate only.

Standard variable rate (SVR) mortgages

The interest rate on a SVR mortgages is set by the lender and can vary over time. SVR mortgages are often the default rate that borrowers move to once their initial fixed or discounted rate period ends. Borrowers on a SVR are likely to be paying more interest than necessary.

It is key to note that lenders need to justify movements in their SVR. Therefore, they generally only change their SVR when base rate moves. The movement will not always pass on a full reduction in Bank of England base rate.

Discount rate mortgages

A discount variable rate mortgage offers a discount on the lender’s standard variable rate (SVR) for a certain period. The discount rate can change along with the lender’s SVR at the lender’s discretion.

This is slightly different from a tracker mortgage in that the rate does not necessarily follow the Bank of England’s base rate movements, however, it is influenced by it.

More information on fixed and variable mortgage rates can be found here.

Understanding how mortgage rates are influenced can help you to make smarter financial choices with your mortgage preferences. If you’re planning a new mortgage or nearing the end of your current deal, contact our team for personalised, expert mortgage advice.

Please call us on 0800 980 8777 or email us at info@privatefinance.co.uk

Your home may be repossessed if you do not keep up repayments on your mortgage.

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