INTEREST RATES RISE AGAIN: WHAT IT MEANS FOR MORTGAGE RATES AND THE HOUSEING MARKET
Tuesday April 25, 2023
The Bank of England has increased interest rates by 0.25% to 4.25%, marking the second increase in as many months. The move comes amid concerns about rising inflation, which is not falling as fast as the Bank had hoped. The decision to raise rates is part of an effort to cool the pace of price increases by reducing demand.
In the US, the Federal Reserve has also raised interest rates this week, despite some problems in the banking system. However, it has signaled that the need for more rate increases is likely over now.
UK mortgage rates have been dropping back
The effect of the interest rate hike on UK mortgage rates is not clear. In the UK, there is a sense that base rate increases are coming to an end, and many borrowers will remember the ultra-low 1.2% mortgage rates reached in September 2021.
Average fixed-rate mortgages have dropped back over the last three months from the highs seen at the end of 2022. Bank of England data shows that the average 5-year fixed-rate mortgage for a 75% loan to value (LTV) mortgage has dropped to 4.38% from a high of 5.6% last October.
Mortgage pricing is complex
How banks set mortgage rates is complex, and there is not a fixed relationship between mortgage rates and the interest rates set by the Bank of England. It all depends on where banks get their funding from in order to lend money out as mortgages – and what this funding costs. They then add a margin onto this cost to reflect risk and a profit margin, which makes the mortgage rate.
Banks use savings from depositors such as households and companies to turn into loans. Current accounts also add to the funding pool. Banks also secure funding for mortgages from the money markets. They can access fixed-rate money for 2 or 5 years or longer. The cost of this money is called the SWAP rate – the cost of swapping variable rate money to fixed money for a defined period.
The price of this fixed-rate finance will be influenced by where markets believe interest rates will go over the period the money is secured for. While base rates might go up in the short term, if the view is that inflation will slow quickly and interest rates will fall, then this may result in SWAP rates being lower than base rates. The 5-year UK SWAP rate is currently 4% and has fallen back from a high of 5.3% last year.
Banks will use a blend of sources as they price mortgages, and this means an increase in interest rates doesn’t necessarily flow into the cost of new mortgages. Borrowers on variable-rate mortgages, where the cost is linked to the base rate, will see mortgage rates increase as the Bank of England raises rates. But for the majority on fixed-rate loans, there will be no change.
Mortgage rates likely to hold where they are for much of 2023
Experts expect fixed-rate mortgage rates for new business to sit between 4% and 4.75% for much of 2023. This is low by historic standards but means the average buyer will face an increase of £200 to £500-a-month more in mortgage repayments than at the start of 2022, when mortgage rates were much lower.
What does the interest rate hike mean for the UK property market?
Many people are wondering how the latest interest rate hike will affect the UK property market. The good news is that experts don’t expect the increase in the base rate to make much difference to the outlook for the housing market. Demand for homes is down on last year, but sales are still being agreed, albeit at a slower rate (20% lower).
