What are swap rates UK and how do they impact mortgage rates?

When it comes to securing a mortgage, understanding the various factors that influence interest rates is important. One such factor is Sterling Overnight Index Average (SONIA) swap rates. In the United Kingdom, SONIA swap rates play a significant role in determining mortgage rates for many borrowers and have been frequently mentioned in the news. In this article, we will delve into what swap rates are and their impact on mortgage rates.

What is an interest rate swap?

An interest rate swap involves a contractual arrangement between two parties, wherein they agree to swap one set of interest payments for another over a specific duration.

What are SONIA swap rates?

SONIA replaced London Interbank Offered Rate (LIBOR) in 2021 as the primary interest rate benchmark in sterling markets. For mortgage rates, lenders use swap rates to protect themselves from interest rate risks and allow lenders to hedge the risk by locking in margins. By ‘locking in’, lenders maintain their margins even if the cost of funds increase, for example, this could be an increase in the base rate. The period can be for a range of terms of 1, 2, 3, 5, 7, 10, 15 or 30 years. Not every bank will choose to hedge using swap rates, some may choose to hedge naturally using saving bonds.

Swap rates reflect market expectations of the future direction of Central Bank interest rates. They are based on the assumptions surrounding what interest rates are expected to be over the term of the swap rate. These assumptions consider factors like inflation, prices of food, fuel, and the general economy which all feed into these forecasts. This is also the rate at which lenders use when setting a price to borrow funds to assist with their own supply and demand.

2-year UK swap rates

A 2-year swap rate is the average expectation of interest rates over the next two years

5-year UK swap rates

A 5-year swap rate is the average expectation of interest rates over the next five years.

How do swap rates impact mortgage rates?

Swap rates only influence fixed-rate mortgages: The higher the swap rate, the higher the mortgage rate before risk and lending appetite are considered. Lenders often see swaps as their cost of funding, and so they need to make a margin on top of these. Rapid movement in swaps can make it hard for lenders to price their products appropriately.

Some lenders may also temporarily withdraw mortgage products if they find themselves offering too competitive of a rate against their competitors following swap rate rises. Potentially, if they don’t increase their pricing, they may become inundated with applications and unable to cope with demand. Despite what the press writes, mortgage products being pulled isn’t as scary as it can seem.

What other factors impact mortgage rates?

It’s important to note that while swap rates serve as a reference point, lenders also consider other factors when determining mortgage rates. These factors include the Bank of England base rate, internal lender targets, service levels, and competitor pricing, as well as many other factors.

Any increase to the base rate directly impacts tracker rates as these are directly linked to the Bank of England base rate. As the name suggests, monthly payments for those with a fixed rate mortgage will remain the same – these are not impacted by base rate movements during the fixed period. The full impact of the increase in the base rate to date will not be felt for some time, until needing to remortgage.

Swap rates and your mortgage

Swap rates in the UK play a crucial role in determining mortgage rates. By understanding swap rates and their impact on mortgage rates, this can help navigate the mortgage market more effectively and make informed decisions. We understand mortgage pricing is not so straightforward and can be quite tricky to get your head around. We are on hand if you have a question about mortgage pricing and how the financial market impacts your mortgage. We continue to monitor the mortgage and wider financial market to observe if any changes may impact our clients.

If your remortgage is due in the next six months, Private Finance can secure your mortgage offer now and lock in a mortgage rate, providing more peace of mind if rates rise further. This offers flexibility to continue to monitor rate movements and respond if conditions change.

Please remember that your home may be repossessed if you do not keep up repayments on your mortgage.

Disclaimer: The views and opinions expressed in this content are those of the author and do not constitute financial, legal, or professional advice, nor should they be interpreted as a recommendation. They do not necessarily reflect the official views, policies, or positions of Private Finance, and are not intended to represent broader market or industry perspectives.

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