Following today's Monetary Policy Committee decision to increase the Bank of England Base Rate by 0.25%, many borrowers will understandably assume that all mortgage rates will immediately become more expensive.
In reality, it’s rather more nuanced than that. In this article, we explain product pricing and what impact we expect for borrowers.
Fixed rate mortgages
Perhaps surprisingly, today's increase is unlikely to have a significant impact on fixed rate mortgages.
Fixed rates are not priced directly from the Bank of England Base Rate. Lenders typically price these using SONIA swap rates, adding a margin for funding costs, risk and profit.
Swap markets have anticipated further increases in the Base Rate for some time, which is why fixed mortgage rates have been sitting significantly above Base Rate for many months. In other words, much of today's announcement has already been factored into fixed rate pricing.
Unless today's decision materially changes expectations for where interest rates are heading over the coming years, we are unlikely to see widespread repricing of fixed mortgages simply because of this 0.25% increase.
This also explains why tracker mortgages have often looked considerably cheaper than fixed rates recently.
Tracker mortgages
Tracker mortgages are the most straightforward to understand.
As these products are typically priced at a fixed margin above the Bank of England Base Rate, borrowers will generally see their interest rate increase by the full 0.25%, with monthly payments increasing almost immediately.
For most borrowers on a tracker, this should not come as a surprise. Anyone selecting a tracker in recent months has generally done so knowing that further Base Rate increases remained a realistic possibility.
One positive is that many tracker mortgages come without early repayment charges. If today's increase means a borrower now prefers the certainty of fixed monthly payments, they may have the flexibility to move onto a fixed rate without incurring redemption penalties.
Of course, whether that is the right decision depends on each client's circumstances and expectations for future interest rates.
Standard variable rates and discounted variable mortgages
Variable rate mortgages are slightly more complicated.
These products are usually linked to the lender's own Standard Variable Rate (SVR), either directly or via a discount from it.
Unlike tracker mortgages, SVRs are not automatically tied to movements in the Bank of England Base Rate. Lenders consider a range of factors when setting their SVRs, including funding costs, competition, profitability and wider market conditions.
As a result, each lender may respond differently.
We have previously seen lenders absorb relatively small changes in the Base Rate without passing them on in full, whilst others have increased their SVRs almost immediately.
Borrowers on variable rates should therefore wait to hear directly from their lender before assuming exactly how today's decision will affect their monthly payments.
Mortgage affordability
One area that often receives less attention is mortgage affordability.
When assessing a new mortgage application, lenders do not simply consider whether a borrower can afford the initial monthly payment. They also stress test the mortgage to ensure it remains affordable if interest rates increase in the future. This is relevant to residential, buy-to-let and commercial borrowing.
Many lenders calculate these stress tests using a combination of the product rate and their Standard Variable Rate.
If lenders choose to increase their SVRs following today's announcement, those stress test rates may also increase. The result could be a modest reduction in the maximum amount some borrowers are able to borrow, even if fixed mortgage pricing remains largely unchanged.
For clients already borrowing close to their affordability limits, this could have an impact on property budgets or future refinancing options.
The bigger picture
Whilst today's announcement is important, it is worth remembering that Base Rate is only one factor influencing the mortgage market.
Funding markets, inflation expectations, economic growth, lender competition and appetite for new lending all play significant roles in determining mortgage pricing.
It is entirely possible to see the Bank of England increase Base Rate whilst fixed mortgage rates remain broadly unchanged, or even reduce if market expectations improve.
As always, the most appropriate mortgage solution will depend on an individual's objectives, attitude to risk and wider financial position. What is clear is that a 0.25% Base Rate increase does not affect every borrower equally, and understanding those differences is key to making informed financial decisions.
To discuss further, please do get in touch,
MSP Financial Solutions
https://www.mspfinancial.co.uk/contact
020 8044 5693
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