Discounted mortgage rates be cautious

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Before I discuss discounted mortgage rates, LIBOR and SONIA, a bit about resolutions…

For many of us, it’s been the first week back in the office after the new year. That rare time of year when you can actually see the bottom of your email inbox. So probably it will be next December before you see that again.

It’s also a time of year when people typically make resolutions. I’m quite interested to know if anyone’s made any or broken any or even believes in making them at all. I’ve gone for a three-prong attack this year.

The three things I’m going to try and do daily are: to meditate, read and exercise. Each of which is a minimum of 20 minutes, so I’m really committing an hour a day of doing what I think is fundamentally quite positive things.

So far so good, I’m sticking to it and if anyone thinks that sounds like quite a lot, just look at the screen time on your phone and I think you’ll soon realise you can easily carve out an hour a day for something more productive.

Variable-rate mortgages: how funded and the mortgage rate you pay

So talking of productive, this update is around variable-rate mortgages and the indices to which they’re linked.

Now before you roll your eyes and think ‘how boring’, this does have a direct impact on how mortgages are funded, and therefore the rate you pay on your mortgage.

There are two aspects to it. One is a market dynamic, which I’ll explain, and secondly a more practical product aspect, which we will probably see as being really, really relevant for the next few years.

LIBOR ending, the introduction of SONIA

The first thing I want to look at is the end of LIBOR. LIBOR stands for the London Interbank Offer Rate.

In 2012 I think it was, quite a few major banks were implicated in the scandal. It was Deutsche Bank, Barclays, Citigroup, JPMorgan, and Royal Bank of Scotland. I think it ended up with a few Barclays bankers actually going to prison over this one.

It was really serious because if bankers are manipulating major indices (as the amount of money that money went through LIBOR was billions in any given day) any slight manipulation around that rate obviously means you can make huge profits, albeit illegally.

So from 2012 onwards, there was of lack of faith in the independence of LIBOR and what’s been introduced instead is something called SONIA (Sterling Over Night Index Average).

This will be starting or has started as of now, because LIBOR is being phased out as of the 31st of December last year, and the full implementation of SONIA is going to come in as of the 30th of June 2023.

Now the London Interbank Offer Rate was always interesting because banks lend money to each other. This is quite common. It could be for a day, it could be for many years.

That’s why money markets are such a good indicator of where mortgage rates are going to go, and where the Bank of England base rate is headed. Because if banks are betting a certain way, this tends to become a self-fulfilling prophecy, unless any unforeseen incidents like Brexit or Covid happen. But all things being equal that’s how it works.

Now in a practical mortgage sense, you’re unlikely to butt up against LIBOR. This is because the only types of lending directly linked to LIBOR tended to be things like private banking deals, development finance, commercial and some buy to let mortgages as well. They typically were linked directly to LIBOR. If you are active in one of these areas and/or your mortgage is linked to LIBOR, you probably will be written to by your bank over the next year or two.

Discounted mortgage rates, be careful

A much much bigger thing that many mortgages are linked to is something called discounted mortgages. These will be prevalent because in a rising interest rate market this becomes really weird.

What are discounted mortgage rates?

All lenders have what’s called a standard variable rate. These are typically anywhere between 3% to 5%, depending on the lender, and it’s a rate they set themselves as an average benchmark of lending.

Even if you have a fixed rate or tracker, after a 2,3, or 5 year period of whatever mortgage type you’ve got ends, you’re likely to be offered a variable rate and it is considerably higher than you’re paying now. Now what quite a few banks do, typically smaller building societies, but not exclusively, is offer something called discounted mortgage rates, which is a discount off that variable rate.

Now it is interesting to note that banks don’t have to link that to the Bank of England base rate, and also they don’t have to update it in time with the Bank of England base rate changes. So why I’m talking about this now is, if you open the Sunday Times or you play around with Meerkats or any sort of comparison tool, what you’ll probably find is variable rates are the cheapest right now.

Delay in updating variable rates vs tracker

Banks expect interest rates to rise in the future so they tempt you in with a lower rate now with the idea that it will go higher later. That’s why I think that potentially a fixed rate is a better value, but you really will really need to look at what the rate you are offered is linked to. This is why I’m doing this update now as probably four or five of the best rates on the market currently are discounted mortgage rates.

Why that’s specifically important now is because banks may not have updated their variable rate since the Bank of England raised their rates. So if you are sorting your mortgage on Monday, you may think,

‘Look at these Best Buy tables. Oh let’s go with that, it’s the lowest rate right on the market.”

However, you might be in for a nasty shock because your mortgage might go up by 0.15%  when that lender updates its rate. So you need to spend a lot more time and effort looking at whether that discounted rate is suitable for you.

You need to look at the lender, you need to look at when they last updated their standard variable rate and then what might happen in the future.

Now for that reason, we’re not a huge fan of discounted mortgage rates because a bank could raise their rate by more than the Bank of England rate rise. They might move their discounted mortgage rates more quickly. They might move them more slowly. You have much less certainty around discounted mortgage rates. So if you do want a variable rate mortgage or something that is penalty-free which typically tends to be a variable rate, it might be better to go for a tracker which is specifically linked to the Bank of England base rate and gives you a lot more clarity.

This may catch people out for the next few years, as we have to go back to 2016 for an expectation that interest rates may rise in this way. The classic thing in our world is the cheapest rate isn’t always the best.

How does this play into mortgage rates as we stand right now?

Money market rates are all up as you’d expect, from the end of last year, anywhere between 0.1 to 0.2%. We’re seeing a rise in SWAP rates for both two and five years and the LIBOR rate has gone up as I suspected as well.

So no major shakes as yet but it’s highly likely based on money markets that the Bank of England will raise rates again in the next three months because LIBOR’s nearly at 0.5% whereas the Bank of England at 0.25%.

Best mortgage rates

So how does that translate into the best rates in the market? Taking into account the above when talking about those variable rates, the cheapest as I say can go from .99% but please be careful what precisely it’s linked to, a two-year fixed rate from 1.09% and a five year fixed from 1.37%, and buy to let starting at 0.99%.

It’s always important to note that the rate you’ll be offered will be dependant on your personal circumstances and your level of deposit because all the rates I have just mentioned would typically be if you’ve got a 40% deposit or more.

Market rates:

Jan 6th	Change	Term
1.428%	0.139%	5 year SWAP
1.351%	0.141%	2 year SWAP
0.483%	0.244%	3 mth LIBOR
0.25%	0.000%	BoE

Best Rates:

2 Year Variable from 0.99% (discount from H&R, Tracker NW)
2 Year Fixed Rates from 1.09%
5 Year Fixed Rates from 1.37%
BTL Rates from 0.99%

The actual rate you will be offered will be dependent on your personal circumstance and deposit level. Please speak to one of our advisers so that they can guide you through this process
Source: Twenty7Tec January 2021

 If you want more advice on this, as it is a tricky area which many people get caught out in, to ensure you get the best product please contact us.