The past couple of years have demonstrated how unpredictable the mortgage market can be, with the deals on offer seeming to fluctuate constantly, even when there’s been no change to the Bank of England base rate.
If you want to try and make sense of why the market acts the way it does and fixed rates in particular seem to move frequently, then understanding so-called “swap rates” is key.
One common misconception is that fixed mortgage rates are directly tied to the Bank of England’s base rate, and therefore move up and down in line with it.
In truth, it’s a bit more complicated than that. While mortgage rates are impacted by the base rate to a certain extent, it’s not a direct correlation. Instead, the deals that lenders are prepared to offer at any given time are based on what are known as ‘swap’ rates. These are the rates that lenders agree to pay the financial institutions that lend them money to fund their mortgages.
In this article, we’ll break down how swap rates work in simple terms and explain how they might affect your next fixed-rate mortgage deal.
Speaking to an experienced mortgage advisor can help you to understand your options and get a great deal on your mortgage. If you’re looking for expert mortgage advice, you can speak to an independent mortgage broker with Unbiased. Every advisor you find through Unbiased will be FCA-regulated, qualified and unconnected to product providers – so they can offer you truly unbiased advice.
How do swap rates work?
We don’t tend to think about it, but in order to lend money to mortgage customers, mortgage lenders first have to borrow that money themselves. Just as most people prefer to have a fixed rate mortgage so that they can plan their finances, pay a consistent amount each month and protect against uncertainty, banks and lenders also want to avoid having to make unpredictable repayments on their own borrowing.
If a lender borrows from the Bank of England directly, the interest rate they pay on that loan is the Bank of England’s base rate, which is set at the BoE’s Monetary Policy Committee meeting eight times a year (around every six weeks). In other words, it’s a variable rate; the amount of interest that the lender would have to pay to the BoE could change regularly, and potentially climb to much higher levels than anticipated if the base rate itself saw any sudden increases.
This is obviously not ideal for a lender that wants to be able to plan its finances well in advance and make a profit from loaning to mortgage customers. If a lender offers you a 10-year fixed rate (or even longer), they have to borrow that amount themselves too and pay it off over a similar term. Naturally, they’ll be reluctant to commit to giving out a secure fixed rate deal if the interest that they have to pay could unexpectedly rise in that same period.
This is where swap rates come in. Rather than borrow directly from the Bank of England and be subject to the potential changes of the base rate, mortgage lenders go to third parties who will give them a fixed interest rate instead. This is what a swap rate is, because the lender is effectively “swapping” the variable rate deal for a fixed-rate one. Lenders then price their fixed rate mortgage deals based on these swap rates, with a profit margin added.
Swap rates change daily, and are calculated based on how the base rate is expected to perform in the future. However, because a swap rate is locked in once the deal is accepted, the mortgage lender can plan their finances in advance and figure out what rates they can afford to offer to mortgage customers. If the base rate fluctuates afterwards, it doesn’t affect the loan.
Like fixed-rate mortgages, swap rate loans are also typically set in increments of two years, five years, 10 years and so on, so these deals can be neatly passed on to mortgage customers. Lenders typically open “pots” of money allocated to each timeframe, based on how many people they think will go for each one. If they have money left over from a certain pot, they might start offering deals at lower rates so they can still make a profit – but there is no real way for customers to predict this, unfortunately.
If a mortgage borrower repays some of a loan early, the lenders typically do the same on their own loan. Bear in mind that if you do want to leave a fixed rate mortgage deal before the fixed rate period ends, there will usually be early repayment penalties to pay.
Do swap rates affect my mortgage?
If you are locked in to a fixed rate deal then changes in swap rates don’t affect you during the term of your deal whatsoever – your monthly payments are fixed until it finishes.
However, if you are approaching the end of your current deal and are looking to remortgage, this is where swap rates have an impact. If swap rates are high at this point, this means fixed mortgage rates will be higher too. Likewise, when swap rates are low, lenders can afford to make their deals more competitive, and low mortgage rates begin to appear.
Swap rates are determined by market projections and are entirely out of our control, so unfortunately there’s not much you can do if you are looking for a new fixed-rate deal and unfavourable swap rates are pushing up mortgage rates. If you are uncertain how to proceed, consider seeking mortgage advice from an expert.
Speaking to an experienced mortgage advisor can help you to understand your options and get a great deal on your mortgage. If you’re looking for expert mortgage advice, you can speak to an independent mortgage broker with Unbiased. Every advisor you find through Unbiased will be FCA-regulated, qualified and unconnected to product providers – so they can offer you truly unbiased advice.
If you are on a tracker mortgage then you are not directly affected by swap rates – your mortgage will typically track the Bank of England base rate directly plus a set percentage, so while your rate might move similarly to swap rates month-on-month, it is not directly tied to them. You can find out more about the differences between fixed and variable rate mortgages in our guide Different types of mortgages explained.
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