Understand the factors that impact the mortgage rates in the UK

Home Understand the factors that impact the mortgage rates in the UK
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Mortgages Sunny Avenue
31 May 2024

As humans, we naturally desire the best in everything, particularly when it comes to our finances. Mortgages are no different, which is why you might be wondering how to get the best mortgage interest rate. You may have been quoted one interest rate, but have seen something better online or even heard from a friend that you can do better.

Unfortunately, getting the best interest rate is not easy and to do so you must consider the factors that impact mortgage interest rates in the UK. 

In this insight, we will cover the key factors that influence your mortgage rate. It's going to help you to understand where you sit in terms of risk to lenders and how to correctly compare the rates you're being offered


Key Takeaways

  • A good mortgage rate depends on factors like loan-to-value ratio, Bank of England Base Rate, and mortgage product term, tailored to your financial needs.
  • Mortgage rates are subject to constant change, influenced by the Bank of England Base Rate and interest rate swaps, making timing crucial for securing a favourable rate.
  • Loan-to-value ratio plays a significant role in mortgage rates, with lower ratios generally leading to more favourable terms and rates.
  • Ultimately, your lender sets the mortgage rate based on their profit margins and customer focus, highlighting the importance of seeking advice and comparing options.

What Is a Good Mortgage Rate?

A good mortgage rate depends on factors like loan-to-value ratio, the Bank of England Base Rate, and the mortgage product term. To qualify for the best rate, you need the lowest loan-to-value ratio, a favourable Base Rate, and a mortgage term that suits your financial needs.

If you consider these factors, you may be on your way to achieving the best interest rate for your given circumstances, yet there's still a lot to consider and so much of achieving a good interest rate is out of your hands. 

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What Influences Mortgage Rates in the UK?

Keep in mind that mortgage rates are subject to constant change, and a rate that was attainable last year may no longer be available now, and finding the best mortgage rate can be like juggling. Making a change in one area could have unintended consequences, setting you back in your search. Before we look into these factors, know that you can seek advice from a mortgage expert, who can apply relevancy and ensure you find the right mortgage for you.

Bank of England Base Rate

The Bank of England is the central bank of the United Kingdom. They meet approximately every 6 weeks to determine the UK's Base rate. The Base rate is the interest rate at which the Bank of England lends money to commercial banks. It has a significant impact on borrowing costs throughout the UK, affecting individuals and businesses alike. When the base rate increases, it typically leads to an increase in the mortgage rates offered for new loans. This is why timing is a huge factor for obtaining a good interest rate. Borrowers who secure a mortgage when the base rate is low can benefit from lower rates, compared to those who obtain a mortgage when the rate is high.

Interest Rate Swaps

It's about to get technical, so brace yourself.

When mortgage lenders borrow money from the Bank of England, they don't agree a loan term with a fixed interest rate as we would, taking a 5-year loan to buy a car as an example. What they do is open a large outstanding pot of money with them and they are charged base rate interest on a daily basis, which is equal to base rate divided by 365 (because base rate is an annual rate). It's a bit like an overdraft.

So, for them to lend you that same money for a mortgage, they have to commit to borrowing from the Bank of England's fluctuating base rate for the next 30 to 40 years, and that is a concern for the mortgage lenders. After all, they need to know what interest they are paying every day, so they know what they can charge you at a slightly higher rate to make a profit.

However, if the Bank of England meets to review the Base Rate every six weeks, how can they know what the base rate will be in 30-40 years? 

There are two measures the mortgage lenders take. First of all, they head into the money markets and agree an interest rate swap for a fixed period of time. That means, they agree with a counterparty to exchange the interest they would pay the Bank of England, in return for paying a fixed interest rate to the counterparty. 

This gives the mortgage lender assurance that they know what interest rate they would be paying for their borrowing. They can now use this interest rate accordingly to determine what they need to charge you.

The second measure they take is to only offer you fixed terms that normally last 2 to 5 years. This reduces the risk the mortgage lenders take on because if you decide to pay back your loan early, they can end their interest rate swap agreement and repay their debt with the Bank of England. For this reason, the Interest Rate Swap that is agreed is normally for the same amount of time as the fixed rate that you take, and if you do pay back your loan during this time you may have to pay an early repayment charge.

However, in practice, what happens is the mortgage lenders will decide in advance how much money they think they will be able to lend to mortgage borrowers and agree the terms of their interest rate swaps for different time ranges. So, they open a pot of money for people who might want a 2-year fixed rate, and a separate pot of money for people who might want a 5-year fixed rate. 

Sometimes in times of rising interest rates, banks still have money left over from their pots, and they can lend at an interest rate that is much cheaper than the current market rate, and they still can make a profit.

How do swap rates affect mortgage rates? in times when Interest rate swaps rates are low, the mortgage lenders will be able to offer more competitive mortgage interest rates.

Unfortunately, as a mortgage borrower, this factor is out of your control. The interest rate swap rates change daily, showing just how quickly the mortgage market can change.

Mortgage Product Terms

The interest rate you get can be largely influenced by your mortgage product terms. If you have a desire to borrow for a fixed term of 2 years, you may expect a better interest rate than if you need stability for 5 years. The difference in interest rates between 2 and 5-year fixed rates is determined by the current price of the interest rate swaps for that period, as explained above. 

If you are comparing interest rates with friends, even if you opt to remortgage at the same time. If your friend has a 2-year fixed rate, and you have a 5-year fixed rate, you should understand that you will likely have a different interest rate.

Loan to Value

Loan to Value (LTV) is a crucial factor in the mortgage world, and it's important to grasp its significance. Simply put, LTV represents the proportion of the property's value that you're borrowing through a mortgage. For example, if you're buying a house valued at £200,000 and you're borrowing £150,000, your loan to value would be 75%.

Lenders pay close attention to LTV because it reflects the level of risk they're taking by lending you the money. A higher LTV indicates a higher risk for the lender, as you're borrowing a larger percentage of the property's value. To mitigate this risk, lenders may charge higher interest rates.

Lower LTV ratios, on the other hand, are generally seen as less risky by lenders. If you're able to provide a larger deposit and have a lower LTV, you may be able to secure more favourable mortgage rates and terms.

When considering Loan to Value, anything below 60% will often provide the best interest rate available. If you are borrowing a 95% or even a 100% mortgage, you can expect to pay the highest interest rate.

Understanding your LTV is essential when searching for a mortgage. It not only influences the interest rates you're offered but also affects your chances of securing a mortgage and the amount you can borrow. Keep in mind that improving your LTV, such as saving for a larger deposit or considering a less expensive property, can enhance your mortgage options and potentially save you money in the long run.

Remember, the lower your loan to value, the better your chances of qualifying for the best mortgage deals. So, carefully consider your LTV when exploring mortgage options and strive to find the balance that works best for your financial circumstances and home-ownership goals.

Your Lender

Ultimately, the mortgage rate you are being offered is determined by your lender. The rate is not only set the profit margins they are trying to achieve but also the type of customer they are trying to attract.

For example, a bank like Halifax are trying to build a brand image that is focussed around helping people to buy their first home. To do this, they may reduce first-time buyer mortgage rates, and may compensate profit levels by increasing their remortgage rates.

Good news if you're a first time buyer, not so good news for those switching mortgages.

This is a perfect example of why it is advisable to speak to an independent mortgage adviser when reviewing your mortgage options.

What is a Good Mortgage Interest Rate for you?

Determining what constitutes a good mortgage interest rate for you depends on several factors that are unique to your financial situation and goals. It's not a question that can simply be answered. It needs consideration of not only your circumstances but also the factors that influence the mortgage rates in the UK.

ABOUT THIS AUTHOR - STUART CRISPE

Stuart is an expert in Property, Money, Banking & Finance, having worked in retail and investment banking for 10+ years before founding Sunny Avenue. Stuart has spent his career studying finance. He holds qualifications in financial studies, mortgage advice & practice, banking operations, dealing & financial markets, derivatives, securities & investments.

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