Swap rates are when two parties swap interest rate payments for another. One party agrees to receive a fixed-rate payment, while the other receives a variable payment.

For mortgages, swap rates are what lenders pay to financial institutions to acquire fixed funding for a set period of time. They can be on a number of terms, including one-, two-, three-, five- and 10-year terms, and the cost is used to price fixed mortgage products for lenders.

Max Shepherd, group economist at Yorkshire Building Society, explained: “Simply, the swap rate is the average market view of where interest rates will be, over the duration of the swap. The two-year swap rate is essentially the average of where [the] base rate is today, and where it is expected to be in two years’ time.

“If an interest rate cut is fully expected in a given month, then in theory the swap rates won’t move if the interest rate cut happens, because the interest rate cut was already factored into the swap rate, and by extension mortgage rates.”

Shepherd noted that, currently, the market is expecting around two 0.25% rate cuts by the Bank of England by the end of this year.

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“This expectation changes constantly as economic data is released. The first cut is expected in either August or September, though any economic data or clues from the Bank of England will change this expectation,” he said.

The Monetary Policy Committee (MPC) is due to meet on 1 August to decide on the base rate.

 

Expectation of a base rate cut ‘has already been priced in’

Stephanie Daley, director of partnerships at Alexander Hall, said that a raft of recent lender rate cuts had led to more optimism of an imminent base rate cut, which raises questions about the direction of travel for mortgage rates.

“Personally, I think the expectation of a reduction has already been priced in. In the last month, we have seen two-year swap rates down 0.18%, three-year swap rates down 0.16% and five-year swap rates down 0.11%.

“During this time, we’ve also seen typical reductions of 0.2% on certain rates from high street lenders and bigger cuts from some of the smaller lenders. We have now also seen a five-year fixed rate price sub-4%,” she added.

Daley said that when the base rate is cut, the “biggest change” would be for SVRs to reduce, which could help some borrowers to access more as it eases the affordability stress tests.

“The other point to note is that we expect to see significant lender competition as they look to drive volumes and market share, and this should also have a positive impact on pricing.

“For consumers, I think the advice is there is no need to wait for a base rate cut to make a decision on future plans – especially for first-time buyers and homemovers. Over a 30-year term, for every 0.25% drop on a mortgage rate, you would save on average £43.90 a month for a £300,000 mortgage [that] is just over £1,000 on a two-year fixed rate.

“Once the base rate does drop, I think this is going to release some pent-up demand in the market, restoring confidence among buyers, which may mean more competition for properties and therefore higher asking prices. Any savings you make on an interest rate will be lost through higher asking prices,” she noted.

Danny Belton, head of lending at Mortgage Advice Bureau (MAB), said that swap rates and the base rate were “not directly linked”.

“While movements in the base rate can impact swap rates, the latter are essentially market forecasts of future base rates. This means that even if the base rate falls, swap rates may not immediately follow suit, as the markets have already priced in this change.

“Lenders will typically use swap rates to determine the rate they set a mortgage at. And with fixed rates dropping below 4% last week, we can safely assume the market has factored in potential rate cuts. A reduction in the base rate could positively impact affordability, as it could lead to a decrease in the lender’s stress rate if the SVR falls as a result,” he explained.

Belton said that only tracker rates were “directly impacted” by changes in the base rate and those on fixed rates would not see any change.

“At the moment we’re seeing some homeowners wait for rates to fall, with some even opting for SVRs. Unfortunately, their expectations may not be met, resulting in higher costs compared to locking into a fixed rate.

“Additionally, lenders often use rates as a tool to manage the flow of business. If a lender receives a significant number of cases, they may choose to increase rates to slow the flow of cases. Conversely, if they aim to increase volumes, they may lower rates,” he said.

 

Swap rates ‘gently trading downwards’ with mortgage rates expecting ‘gentle decline’

David Baker, managing director of LIFT Mortgages, reiterated that base rate cuts and swap rate drops were “different things, yet clients and many brokers rarely understand this”.

He said: “It is widely predicted a base rate will be cut soon and so when it is cut, I wouldn’t expect to see dramatic changes in rates because it’s been predicted for a long time and the market saw it coming.

“The number of future predicted cuts is actually more interesting than the base itself, and often the commentary around where the MPC think rates are going will move the market more than the actual base rate decision itself. Often movements in the US have more effect than data here.”

Baker said that currently lenders were cutting rates, although swap rates were not falling “dramatically” and rates “aren’t actually much lower than last month”.

“What you’re seeing at the moment is the lenders passing on more of the saving than they had done previously as they fight for business,” he said.

Mark Harris, chief executive of SPF Private Clients, said that the current trajectory in the base rate has “already been priced into new mortgage rates by lenders”.

He continued: “Swap rates have been gently trading downwards in recent weeks and lenders, keen to increase business volumes, have cautiously followed suit by reducing their mortgage rates.

“Should the base rate deviate away from the projected trajectory – either up or down – we would expect to see more significant changes in pricing. Current market expectations are for one quarter-point base rate reduction this year, followed by one per quarter in 2025, hitting 4% by December 2025. The most likely course for mortgage rates over that period is a gentle decline, with borrowers hoping for drastic reductions likely to be disappointed.

“What is of more interest in some ways than the Bank of England rate decision on Thursday will be the voting split of the committee, as well as any commentary that emerges as to the future direction of travel of rates.”