How does SONIA swap rates affect the mortgage interest rates in the UK? | WIS Mortgages
How does SONIA swap rates affect the mortgage interest rates in the UK?  image

8th September 2023

How does SONIA swap rates affect the mortgage interest rates in the UK?

The complex world of finance, with its myriad of factors influencing the daily lives of people, often appears like an enigma. Among these factors, interest rates play a critical role, impacting everyone from large-scale corporations to homeowners repaying mortgages. In the UK, the Sterling Overnight Index Average (SONIA) swap rates and their effect on mortgage interest rates is a subject of high significance.

Understanding SONIA Swap Rates

Before delving into the relationship between SONIA swap rates and mortgage interest rates, it helps to understand what SONIA is and how it works. SONIA is essentially an interest rate benchmark. It measures the rate at which interest is paid on an unsecured overnight loan between banks in the sterling markets. SONIA is also a reflection of the general state of the economy and the Bank of England's monetary policy.

SONIA swap rates, on the other hand, are interest rate derivatives based on the SONIA benchmark. They allow financial institutions to swap fixed and floating rates of interest. The swapping of interest rates provides a way for these institutions to manage risk, and it also gives an indication of future market expectations.

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How does SONIA Swap Rates Affect the Mortgage Interest Rates in the UK?

To understand the link between SONIA swap rates and mortgage interest rates, it's important to recognise that mortgage lenders closely monitor the money market when setting their rates. The money market is the sector of the financial market in which financial instruments with high liquidity and short maturities are traded.

Swap rates, including the SONIA swap rates, are part of this money market. The rates for swaps are indicative of the average rate that the market anticipates over the length of the swap. If SONIA swap rates rise, this suggests the market is anticipating an increase in interest rates. Mortgage lenders, in response, may increase their mortgage rates.

Direct Implication on Mortgage Rates

The most direct impact of rising SONIA swap rates on mortgage rates is for those on variable rate mortgages. The standard variable rate (SVR) that many lenders use can go up or down at the lender's discretion. However, a key factor influencing the SVR is the general state of interest rates in the economy, as reflected by SONIA.

For those on fixed-rate mortgages, an increase in SONIA swap rates would not impact their current mortgage rate. However, if they were to remortgage or reach the end of their fixed rate period, the new rates available to them would likely be higher.

Indirect Implications on the Economy

While not a direct link, SONIA swap rates can also have indirect effects on mortgage rates through their impact on the wider economy. If SONIA swap rates are high, this suggests that banks expect higher borrowing costs in the future, which could slow down the economy. In response, the Bank of England might lower the base rate to stimulate economic activity. This, in turn, could lead to lower mortgage rates.

However, if SONIA swap rates are low, this could suggest that the economy is doing well and that there is a low risk of default. The Bank of England might then decide to increase the base rate, which could result in higher mortgage rates.

Explaining the Current State of Swap Rates

Swap rates have been quite volatile in recent times due a few different factors. These include multiple base rate increases, insights surrounding inflation and a general uncertainty around the market. Other external factors, such as the ongoing conflict in Ukraine, have played a part in the volatility of swap rates. These fluctuating swap rates have been in effect since the Bank of England raised the base rate. The mini-budget announcement in September 2022 was a trigger of sorts, causing swap rates to spike very quickly.

Although there's no way to definitively know when swap rates are likely to plateau, a good indicator is looking at inflation. When inflation becomes more controlled, the base rate should start to drop. In June 2023, the base rate rose from 0.5 % to 5 %, with the most recent forecasts predicting base rates to hit around 5.5 % over the next few years.

SONIA Swap Rates and Mortgage Interest Rates are Connected

SONIA swap rates have both a direct and indirect effect on mortgage interest rates in the UK. They provide a key signal for the money market and mortgage lenders regarding the expected future direction of interest rates. By monitoring SONIA swap rates, both lenders and borrowers can gain valuable insights into the likely future direction of mortgage rates.

If you'd like some advice or guidance around your mortgage interest rates, then get in touch with our team at WIS Mortgages.

Frequently Asked Questions

Q. How do swap rates impact mortgage rates?

A. Swap rates and mortgage rates are tied together, so if the swap rates rise then the interest rates found in a fixed rate mortgage will also rise. Similarly, if the swap rates drop then mortgage rates also drop. These changes are determined by predictions made by investment banks about the future costs associated with borrowing.

Q. Are mortgage rates based on SONIA?

A. There are several things that go towards setting mortgage rates, but the three big ones are internal targets and competitor pricing, the Bank of England base rate changes and the 5-year SONIA swap rates.

Q. How is SONIA interest calculated?

A. The Bank of England is responsible for calculating SONIA by establishing a trimmed mean of interest rates. They look at the interest rates paid on all eligible transactions. In this context, trimmed mean is essentially a volume-weighted mean rate that stems from the central 50 % of volume-weighted distribution of rates.

As a mortgage is secured against your home/property it may be repossessed if you do not keep up with the mortgage repayments

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