Up or down – how do lenders set their interest rates?

With the base rate rising and lenders changing interest rates regularly, a popular question we get asked is: “If the base rate hasn’t moved, why has the interest rate available from lenders gone up?” or “The base rate went up, but lenders haven’t changed their rates. Why is this?”

Many factors play into making an interest rate. Often lenders will tweak their rates to ensure they are not market-leading, as they wouldn’t be able to cope with the volume of applications, but other economic factors can play into it too. With the majority of mortgage products being fixed rates, lenders look to swap rates to assist them in their pricing.

Swap rates are in essence the wholesale cost to the lender of borrowing money to lend. They give a blended estimate of where the market sees the base rate being over a set period of time and this can fluctuate daily. Lenders expect minor fluctuations in the swap rates, however when unexpected announcements are made concerning base rate, inflation or anything of note to both the UK and world economy, larger changes take place.

Once a lender has figured out their cost of funds (the relevant swap rate or interest rate they pay savers), they then have to add their profit margin plus the cost of administering the loan. The lender also has some other choices to make, such as how they wish to divide the rate they need to charge between the mortgage interest rate and the product fee. For example, they can choose to offer a low rate with a higher fee or a higher rate with little or no fees. 

High street banks have an advantage over specialist mortgage lenders in that they will have customer’s savings that they can lend a proportion of. This often costs the bank far less than wholesale money and means that they can lend at more attractive rates.

Lenders spend a huge amount of time researching the market, following trends and making predictions, all of which helps to explain why interest rates won’t always change as quickly as you may expect when the base rate is adjusted.