Betting The House
Capital & Interests: Fixed Feelings:- How Swap Curves Affect Your Mortgage
Harry Arnold 05.12.2024
Hands up if you know what a swap curve is. Not a trick question, but a tricky one, certainly.
In truth, homeowners and prospective buyers shouldn’t need an economics degree to understand the humble mortgage. At its core, the concept seems simple: rates go up, you pay more; rates go down, you pay less. But what happens when the headline-grabbing base rate (Bank of England base rate) decreases while the rate that matters to you (the fixed rate) goes up?
To understand it, let’s break down what a fixed-rate mortgage really is.
In reality, lenders don’t lend purely from their own deposits, instead they trade liquidity and capital with each other at scale, allowing them to use their balance sheets to buy large tranches of money at fixed prices, then package it up for borrowers as fixed-rate mortgages. Just like that - hey presto! - you’ve got your mortgage.
This system has worked brilliantly for the UK housing market since the 2008 financial crisis. Competitive fixed-rate mortgages allow consumers to plan their finances with some degree of stability, and reduces their exposure to the stormy seas of the Bank of England’s base rate.
Before 2008, the majority of mortgages were tied directly to this base rate, and the housing market was extremely sensitive to rate changes. A single adjustment made by the Bank of England could immediately impact monthly payments: a small but fast-moving lever, compared to the very slow, but huge hammer that’s been put down on the economy over the last two years. Has anyone else noticed that house prices have remained stable over this recent fiscal tightening cycle, without the sharp spike in repossessions and price crashes that defined the early 90s?
Here’s where the swap curve comes into play. Lenders keep an eye on the price of money in the financial markets, and use those figures to determine the rates they offer. This price, called the spread, reflects what traders believe the base rate will average over the duration of your mortgage product. It’s essentially a bet: we reckon the base rate for the next two years will be this, so the rate for your 2-year fixed mortgage should be that.
The latest chapter of these financial times has introduced further complexity to these calculations. The government has announced plans to borrow heavily to invest in infrastructure and the NHS. Although this is an important initiative, it could act as an invitation for suppliers to increase prices - there’s a willing buyer in town for manpower, cement, consulting contracts, tarmac and MRI scanners. On top of this, consider the global uncertainties stirring up concerns - the potential for a US-led trade war, for example, with the threat of tariffs pushing up prices on all goods traded between those countries or trading blocs.
So, when the prospect of inflation seems uncertain, what does the Bank of England do to keep prices stable? You guessed it. They raise interest rates - or as they like to call it: “keep rates at a sufficiently restrictive level to bring inflation back to target.”
That’s why Fixed mortgages have been rising - the market is betting that rates will come down on a slower trajectory than they thought it would a month ago. Before the government’s budget announcement, most prime mortgages were available between 3.8% - 4.5%, with a base rate of 5%. Now, despite the base rate dropping slightly to 4.75%, predictions of slower rate cuts to come have kept mortgage rates higher, hovering between 4% and 5%.
While navigating today’s mortgage market may feel daunting, a little understanding around these underlying dynamics can help you make more informed decisions, which is why a good mortgage advisor is a sensible ally to have in your corner. Fixed-rate mortgages are a valuable tool for managing financial stability, especially when times are uncertain - but if you’re considering your options, it’s always wise to sit down with a trusted advisor, who’ll help you assess the market and find the best solution for your needs.