July 2023


Talk to any mortgage broker at the moment and the first subject that comes up is product withdrawals, and interest rate changes on fixed rate mortgages.

There has been significant upheaval in recent weeks, with mortgage lenders of all shapes and sizes feeling compelled to pull some or likely all of their fixed rate products, and relaunch them later on at noticeably higher interest rates.

The speed and size of these changes has led some to talk of the market feeling like September 2022, specifically the aftermath of the disastrous Trussonomics mini-Budget which effectively ended Liz Truss’s premiership.

But at the heart of what’s going on has been the role of Swap Rates, a subject that can seem confusing but which is vital for brokers to have a good grasp of.

Why Swap Rates matter

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.

Effectively the two parties involved – the mortgage lender and the funding institution – agree to ‘swap’ the interest rate payments they will be getting from assets they hold. One will be focused on getting a fixed rate payment, while the other will be keen on receiving a variable interest rate payment. The trade will see each party take on the income – and therefore the risk – from those specific assets.

Key to those Swap Rates is the expectation of what lies ahead for the bank base rate. If the market expects further increases, then Swap Rates go up, while if the expectation is for base rate cuts then Swap Rates will start to decline.

In essence, the Swap Rate is what the lender agrees to pay the financial institution for the funding it then uses for its lending activities. The Swap Rate then influences the pricing of its mortgage products, and its profit margin. A failure to properly account for the future cost of lending on fixed rate, term mortgages could undermine the lender’s financial stability, and its ability to continue to bring products to the market in the future.

Given the importance of Swap Rates in funding and pricing mortgage deals, fluctuations in Swap Rates then have a big impact too.

If Swap Rates spike, increasing rapidly, then lenders will be forced to act, and that’s what we have seen of late. In the last few weeks we have seen hundreds of mortgage products pulled and repriced by lenders across the industry, from those focused on vanilla residential borrowers to those targeting the more niche, underserved areas.

This has all been driven by concerns around what lies ahead for base rate. The latest jumps in Swap Rates have been the result of data from the Office for National Statistics around the ongoing high rate of inflation, which is proving rather more stubborn than might have been expected given the Bank of England’s decision to increase bank base rate on 13 successive occasions to date.

This simply raises the prospect of more increases ahead, and that expectation has led to the noticeable jump in SWAP rates.

In truth it’s not altogether different from September 2022, when the financial markets determined that the bank base rate would have to increase substantially as a result of the measures announced by the Government.

Mortgage lenders have therefore had to react. It’s not just a question of profit margins either. As their rivals have repriced, some lenders have found themselves at risk of attracting too much business, potentially exhausting their funds and putting their processing under undue pressure.

What SWAP rates mean for mortgage advice

Clearly, understanding Swap Rates and what’s likely to happen with them in the future is useful for mortgage brokers. That way advisers can ensure that their clients are as informed as possible when making product decisions.

For example, if we see positive economic data published, particularly around inflation, that may mean that the Bank of England holds off on further increases to bank base rate. This could lead to a reduction in Swap Rates and therefore the launch of more competitive fixed rate mortgage products.

The reverse is also true though – as we have seen of late, all it takes is for some unexpectedly negative economic data and the resulting expectations of future bank base rate increases can lead to Swap Rate spikes and costlier fixed rate mortgages.

Given the speed at which Swap Rate changes can have an impact on fixed rate deals, it’s useful for brokers to engage with the Swap market so that they are best placed to guide their clients on what the future may hold.

Anna Lewis, Director of Proposition & Strategy at Castle Trust Bank