How lenders fund mortgages!

Barlow Irvin’s Practice Principal, Gary Oxborough, explains the process of how lenders fund mortgages!

As there has been so much turmoil in the mortgage market recently, with rates rising quickly and lots of misinformation in the media, I thought I’d try and put some perspective on matters and explain how lenders fund mortgages and how they get to the interest rates they charge.

You will be aware of the Bank of England Base Rate, which is reviewed normally on a monthly basis by the Monetary Policy Committee at the Bank of England. You will also be aware that the base rate has increased over recent months from its historic low point of 0.1% to its current level of 2.25%. This has been due to the Bank of England trying to control the rate of inflation, which is running at around 10%, well in excess of the target of 2%.

One of the main misconceptions around mortgages is that this increase directly affects the fixed rate mortgages on offer. However, fixed rates have increased by much more than the increase in the base rate in recent months, from around 2% to the current average of between 5.5% and 6%, a much larger jump than the base rate increase. To understand the reasons behind this increase, we need to understand how mortgage lenders raise the funds for mortgages and how this affects the rates they can charge.

A lender’s funding comes from various sources, including customers’ savings, government funding schemes and wholesale markets, which can change quickly depending on the wider economic context. For example, the ongoing war in Ukraine, the energy crisis and soaring inflation has profoundly impacted the environment in which the industry is operating over the last few months.

For fixed rates, lenders use swap rates, where – as the name suggests – two different parties swap interest rates. That means the price of a fixed rate mortgage is based on the price at which they can borrow in the swap market.

The bank base rate has gone up by 2.15% over the last year, but at the same time, two-year swap rates, which drive funding costs for fixed rate mortgages, have gone up by 5.10% (from 0.44% to 5.56% as of 26 September 2022).

Swap rates reflect forecasts on what the Bank of England base rate may be in the near future, and with widespread expectations that interest rates will continue to climb, that’s directly impacting on the swap market.

Whilst I understand that the reasoning behind the increases does not lessen the pain of increased mortgage payments, I believe it’s important to understand why these increases have happened recently.

On a positive note, although there is a strong possibility that the Bank of England will increase the base rate again in the near future, as inflation is still running way too high, this may not have a major affect on the fixed rates currently on offer, as these increases will already have been “priced in” to the fixed rates available. Of course, nobody can predict the future as we have seen recently.

As always, your personal circumstances are the most important part of any conversation we have around mortgages, so please get in touch with our award-winning team if you have any questions or concerns.

As a mortgage is secured against your home or property, it could be repossessed if you do not keep up mortgage repayments