Moneyfacts data also illuminates the impact that these product changes have had on the sorts of interest rates on offer to mortgage borrowers. It found that the typical two-year fixed rate mortgage moved from 5.49% to 5.86% at the start of June 2023, which further increased to 6.01% later in the month, while the average five-year fixed rate has risen from 5.17% to 5.51%.
One of the big factors behind the speed of these product changes has been changes in Swap Rates. However, Swap Rates and the role they play in the setting of mortgage products can be an area of confusion among mortgage intermediaries.
What are Swap Rates?
Many mortgage lenders have to raise the funds used for their mortgage activities through the financial markets. That means partnering with financial institutions to raise funds over a set period of time.
That agreement sees the mortgage lender and the financial institution ‘swap’ interest rate payments with each other. One will be keen to receive a fixed rate payment on their money, while the other wants to take a variable interest rate, and that keenness will ultimately come down to what they expect to happen in the future with base rate.
At the time of the agreement between the two parties in the swap, the two cash flows from the interest rates will be the same - essentially neither side is profiting from the deal. The profit from the exchange will then come to which side is right about what happens next with bank base rate.
Within a mortgage context, the SWAP rate is effectively what the lender has agreed to pay the financial institution for the funding it has arranged over that set period, which it will be using for its mortgage lending.
The mortgage lender will then price its mortgage products - specifically its fixed rate mortgage products - based on that SWAP rate, with a profit margin on top.
Why have SWAP rate spikes led to mortgage product withdrawals?
The dramatic pace of product changes seen in the mortgage market of late are directly tied to changes in Swap Rates.
Recent data from the Office for National Statistics (ONS) around inflation has increased the expectation within the money markets that there will have to be further increases to the bank base rate. While the base rate has been increased on 13 consecutive occasions as at June 2023, there had been optimism that the rises would soon be coming to an end.
Just a few weeks ago, the consensus among the markets was that base rate was unlikely to pass 5%, but since the publication of the ONS data, the forecasts are now that base rate will probably hit 5.75% by the end of 2023.
These changing forecasts have meant that the rates demanded by financial institutions for that funding has grown too. Mortgage lenders have therefore had little alternative but to reprice their product ranges in order to reflect the higher rates they are having to pay for that funding.
In many cases this has meant withdrawing their fixed rate product range so that they can be repriced at higher rates.
However, it’s important to understand that while Swap Rates have been an important factor, they have not been the sole driver by any means. Instead market share and lending targets have also come into play.
Some lenders with more modest ambitions have found that they are now offering some of the cheapest deals on the market and so have felt the need to withdraw themselves. This can also come down to fears around being overwhelmed with applications and the desire to avoid letting service standards fall.
So while it has been Swap Rates that have led to the product withdrawals seen in recent weeks, demand from borrowers and a desire to avoid becoming overly exposed has contributed to the accelerated rate of change.
Will Swap Rates continue to rise?
Swap Rates, and the likely future direction of travel for mortgage interest rates, are an important consideration for all mortgage brokers.
Ultimately, the future for Swap Rates will all come down to how likely it is that the Bank of England will feel the need to continue increasing the bank base rate. If the inflation figures improve, and it appears that the existing increases have done enough, then we may see Swap Rates start to drop in the weeks and months ahead.
However, if the inflation data continues to be high, this may necessitate further increases to bank base rate. As a result, Swap Rates may also rise, leading to higher pricing of fixed rate mortgages.
This uncertainty will continue to play a role in lender appetite and the pricing of their fixed rate products, and so should be taken into account when making mortgage recommendations to borrower clients. While there is no crystal ball to offer a clear picture of what lies ahead, by monitoring the SWAP markets brokers can ensure they are on top of what’s most likely to take place in the future.
Source - Financial Reporter
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*Based on a mortgage of £270,000 repaid over 25 years at a rate of 5.29%, the amount repayable over the lifetime of the loan will be £487,341. At a rate of 5.04%, the amount repayable will be £477,201, saving £10,140.
Your home may be repossessed if you do not keep up with your mortgage repayments. Charges may apply. Rates often fluctuate and therefore are subject to change at any time. Nothing in this article is to be interpreted as advice.