For homebuyers, understanding why mortgage rates fluctuate is key to making informed decisions. One of the most significant factors influencing fixed-rate mortgage pricing is SONIA (Sterling Overnight Index Average) swaps. But what are SONIA swaps, and how do they impact mortgage rates? Let’s break it down.

What Are SONIA Swaps?

SONIA is the benchmark interest rate for unsecured overnight lending between banks in the UK. Financial institutions use SONIA swaps as a tool to manage interest rate risk and predict future borrowing costs. These swaps represent the market’s expectations of future interest rate movements, which directly influences the pricing of fixed-rate mortgages.

How SONIA Swaps Affect Fixed-Rate Mortgage Pricing

1. Cost of Funding for Lenders

Mortgage lenders don’t typically fund their loans directly from deposits. Instead, they borrow from financial markets, often using SONIA swap rates to lock in a fixed cost over a given period. When SONIA swap rates rise, the cost of securing fixed-rate funding increases, leading lenders to raise mortgage rates. Conversely, if swap rates fall, lenders can offer lower mortgage rates to borrowers.

2. Market Expectations for Interest Rates

SONIA swaps reflect market sentiment about future Bank of England base rate changes. If traders and institutions expect the BoE to increase interest rates, swap rates will climb, pushing up fixed mortgage rates. Conversely, if the market anticipates a rate cut, swap rates tend to drop, making fixed-rate mortgages more affordable.

In the lead-up to the BoE meeting, bets on rate cuts by the central bank this year have firmed up significantly. Traders are now wagering on 79 basis points of rate cuts by the BoE this year, meaning they are fully pricing three quarter-point reductions by the end of the year. That has meant that the swap rates used as a reference for pricing fixed-rate mortgages have fallen further in recent days. Five-year swaps are now below 4%, and two-year swaps are heading in the same direction. While both rates are slightly higher today, the two-year rate hit its lowest level since October yesterday.

3. Lender Pricing Strategies

Mortgage lenders continuously monitor swap rates when setting fixed-rate deals. Some lenders may anticipate future swap rate movements and adjust their mortgage offerings proactively. This means that even before the BoE announces rate changes, fixed mortgage rates may fluctuate based on swap market activity.

And that’s being accompanied by mortgage rates being cut by lenders. Halifax has reduced rates today, while Barclays and Coventry Building Society have also announced cuts on some products this week.

4. Competition & Borrower Demand

While SONIA swaps play a crucial role, competition among lenders and borrower demand also influence mortgage pricing. Even if swap rates rise, some lenders may absorb part of the cost to maintain competitive rates. However, prolonged increases in swap rates will inevitably lead to higher fixed mortgage pricing.

Considering a Variable Rate Mortgage

For some homebuyers, opting for a variable-rate mortgage may be an attractive alternative if they believe the Bank of England base rate is set to fall. Unlike fixed-rate mortgages, variable rates fluctuate in line with changes to the base rate. If the BoE reduces rates, borrowers on a variable mortgage could see their monthly payments decrease, making their mortgage more affordable over time. However, this comes with the risk that rates could move in the opposite direction, so it’s important for borrowers to assess their risk tolerance and financial flexibility.

Need Mortgage Advice? We’re Here to Help

Navigating mortgage rates can be complex, but you don’t have to do it alone. Our mortgage brokerage can help find the best mortgage options available.