Base rate rises but mortgage rates expected to stay the same
The latest rise in the base rate to 4.25% is unlikely to have an impact on mortgage rates in 2023, which are set to stay at 4% - 4.75%.
Base rate rises to 4.25% but mortgage rates to stay at 4-4.75% for 2023
23 March 2023
Executive Director - Research
The latest rise in the base rate to 4.25% is unlikely to have an impact on mortgage rates in 2023. Our Executive Director of Research, Richard Donnell, explains why.
Key takeaways
The Bank of England has increased the base rate by 0.25% to 4.25%
However, mortgage rates for new borrowers are likely to remain between 4% and 4.75% for much of 2023
Mortgage rates are set by multiple factors, including the different costs of money for banks
And they have dropped back to an average of 4.5% over the first 3 months of this year
Interest rates rise again
The Bank of England increased interest rates one more notch, from 4% to 4.25% today. Inflation isn’t falling as fast as some had hoped, opening the door for more monetary tightening to reduce demand and cool the pace of price increases.
In the US, the Federal Reserve has raised interest rates again this week, despite some problems in the banking system. However, it has signalled that the need for more rate increases is probably over now.
UK mortgage rates have been dropping back
It’s not clear whether a further small increase in UK interest rates will push mortgage rates much higher. In the UK too there is a sense that base rate increases are coming to an end.
Average mortgage rates have dropped back over the last 3 months from the highs seen at the end of 2022. Bank of England data shows 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.
What many borrowers will remember is the ultra-low 1.2% mortgage rates reached in September 2021. This was the low point, before rates started to increase over 2022 as inflationary pressures built up, which were then boosted by the impact of the mini budget late last year.
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.
This is why higher loan to value mortgages attract slightly higher mortgage rates, as there is more risk lending at 90% LTV than say, a 50% LTV mortgage.
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
We expect 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.
We 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).
People still want to move and households are resetting their plans in an environment of higher borrowing costs. Talk of a big price correction in home values has been overplayed and if you price your home sensibly, it’s likely to attract interest subject to some negotiation on the final price.
source: Zoopla.co.uk