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How Mortgage Rates Work

Richard Campo, founder and managing director of a recommended mortgage and protection advisors Rose Capital Partners, explains how mortgage rates work and how to take advantage of them:

 

As we adjust to this new political norm, I have taken a step back to look at some basic market fundamentals to see where we are and what we can learn.

In essence, funding for a mortgage is actually very simple (or I would not be able to understand it!). There are 3 key factors to consider – LIBORtwo year SWAP rates and five year SWAP Rates and the relationship between them. By understanding how they relate to one another, you can start to see how funders view the market and shape a picture of the future.

How these work are as follows:

LIBOR stands for London Inter Bank Offer Rate. LIBOR is a true reflection of the rates at which banks lend to one another and typically funds Tracker Mortgages. LIBOR tries to guess when the Bank of England will move their Base Rate. When three month sterling LIBOR reaches 0.25% above or below the current Bank of England base rate, expect a rate move in that direction in the next 3 months. I track this closely as it hugely impacts on the advice we give. Huge word of caution here is that this is the “market expectation” and is by no means a guarantee. We have seen quite large increases in LIBOR the last few years but the Bank of England haven’t moved rates. This is very much an art, not a science, as so many factors play a role in when the Bank of England moves rates. LIBOR also reflects the availability of money as well as cost. At this point it starts to get more complex so I may pick up this another day. With such a nominal difference between LIBOR and the Bank of England Base rate, I do not expect anything to happen any time soon, which is a logical stance until we know what (if anything) is going to happen on the 31st October.

Two and five year SWAPs work exactly the same way. These are the money market’s guessing where rates will be over the next two or five years which has a huge impact on the price of fixed-rate mortgages. There is no doubt we have many obstacles ahead and the economy may get worse before it gets better. I personally think rates will go up faster in the next three, four or five years than one may expect, which means the economy will also be growing. Again, the standard word of caution here that no one knows where rates will ultimately go: it is all educated guess work. However, I believe that people are disproportionally influenced by recent events. So, in my humble opinion, that makes 5 year deals look like great value.

I have added a graph below so you can see the interplay of these aspects:


 


Banks will then apply whatever margin they feel is appropriate to the above market rates. That will take into consideration your personal situation like credit profile, income and deposit, hence why speaking to an adviser is so crucial. As a guide, the best rates on the market will be above 0.75% + the benchmark rate (however we haven’t seen 5 year fixed rates come down as much as market rates have done over the last couple of months), but if you have a very complex situation that could be as high as 4% + the benchmark. The advantage is that no matter how complex your situation, money is cheap. If you go back to November 1999 when I started in mortgages, the Bank of England base rate was at 5.5%, which meant a market leading rate would have been around 6.25%! Irrespective of the wider situation if your situation permits it, take advantage of this stupidly cheap money.

The above is all well and good, but if you have a specific need, your own view on rates or a set situation, it then is a case of finding the most suitable product, not just the ‘cheapest’. That is why advice always plays a role as it is not a one-size-fits-all policy. Also, one of our core values is getting our clients debt free as soon as possible. With money so cheap, it has never been so possible to pay off debt so quickly. Don’t miss this window: if the economy picks up over the next few years interest rates will also be on the up. Only a fool would try and call such a complex market,  but if we look historical trends there is no denying we are at or near the bottom of this rate cycle. This again reinforces my view that locking into a longer term fixed rate now will reap dividends down the line.

 

If you would like to discuss anything raised in this blog, please do not hesitate to contact us and we will be more than happy to help.

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