Interest rates have dominated the personal finance news agenda ever since they dropped to record lows in the pandemic era.
After that, the Bank of England incrementally increased its base rate in response to inflation, which has had significant knock-on effects on consumer finances.
But how does the Bank of England decide the base rate, how exactly does it affect you, and what is the situation now?
Mortgage rates, base rates and swap rates: What’s the difference?
A mortgage interest rate is the interest rate charged by mortgage lenders on loans taken out to buy a property.
Fixed-rate mortgages are the most popular choice among borrowers, with 81% opting for this type of product as of June 2023, according to the most recent public UK Finance data.
Alternatively, you can choose a variable rate mortgage, where the interest rate and monthly repayments move in line with a specific reference rate such as the base rate or a lender’s Standard Variable Rate.
The base rate, meanwhile, is the interest rate set by the Bank of England, and is used to maintain overall economic stability, as well as control inflation. The Bank’s Monetary Policy Committee (MPC) meets every six weeks to assess whether adjustments are needed.
When inflation is well above the Bank’s target, you can expect increases to the base rate with the idea of discouraging spending and preventing prices from rising too quickly.
A slightly more complicated, but equally important, type of interest rate is a swap rate. In short, this is the interest rate that lenders pay to offset the risk of fixed-rate lending and, as such, is a major contributing factor to the final mortgage rate offered to a homeowner.
A deep dive into swap rates
To delve into a bit more detail, an interest rate swap is a contractual agreement between two parties. It involves the exchange of one set of interest payments for another and allows mortgage lenders to swap out fixed interest rates on interest they receive from ‘fixed rate’ mortgage customers for a variable interest rate instead.
Swaps are based on a variety of factors, including UK government bonds (commonly known as gilts). When you buy a gilt or government bond, you are effectively lending your money to the government that issued that bond.
Swaps tend to reflect future expectations for the Bank of England’s base rate, taking into account predictions for interest rates throughout the duration of the swap. So, how do these rates tie together? Essentially, the interest rate you pay on your mortgage is heavily influenced by swaps, which in turn are based upon future expectations for the base rate.
What’s happening to rates now?
Following a bumpy year for interest rates in 2023, this year’s outlook is much more promising. Strong competition between lenders on pricing saw some fixed rate products stoop below 4% at the beginning of the year.
Since then, we have seen a moderate uptick, with the average five-year fixed mortgage now sitting at around 5%. However, with inflation now meeting the Bank of England’s 2% target, many are suggesting that a base rate cut is a real possibility.
Although a projected base rate cut may well be already priced into several deals, it remains true that the anticipation of such a thing has coincided with lower swap rates and a surge in activity in recent months.
Lending via the Legal & General Mortgage Club was 9% greater in Quarter One (Q1) 2024 compared to the same period last year, marking the highest Q1 lending amount in Mortgage Club history. While the base rate still sits at 5.25%, there’s plenty to signal that we’re in a stronger position and confidence is returning among buyers and sellers alike.
But in a climate where interest rates rarely sit still, and the choice of available options is so vast, choosing the right product is no straightforward task.
Whether you’re looking for your first property, or your next move, independent professional advice should be your first port of call.
Advisers can break the market down, simplify the complexities, and put you in a position to make informed financial decisions. Interest rates can seem very complicated to get your head around, but with the guiding hand of an expert adviser, it needn’t seem a daunting prospect.
Clare Beardmore is director of distribution and mortgage club at Legal & General Mortgage Services
