2024 - the year for reassessing borrowers' options

A New Year, and the news for borrowers looks to be improving. Having struggled with affordability issues since September 2022, mortgage swap rates have fallen but inflation is proving remarkably sticky. The Consumer Prices Index (CPI) rose by 4.0% in the 12 months to December 2023, up from 3.9% in November, and the first time the rate has increased since February 2023.

All this may change, of course, but the tone and mood are a vast improvement. The markets' opinion can be seen in the steady fall in swap rates – significant for lenders, brokers, and borrowers alike.

Borrowers are swamped with information which is why good advice is so important if they are to also understand why some decisions are better than others. Swap rates are increasingly in the media so it’s important to be able to explain what they are and how they influence product selection.

An interest rate swap is essentially a contractual arrangement between two parties, wherein they agree to swap one set of interest payments for another over a specific period. Today, SONIA has replaced the London Interbank Offered Rate (LIBOR), which fell foul of the LIBOR scandal, as the primary interest rate benchmark in sterling markets.

Lenders use swap rates in their fixed rate mortgage products to protect themselves from interest rate risks. The process allows lenders to hedge the risk of moving prices by locking in margins. In doing so, lenders maintain their margins even if the cost of funds increases, for example, this could be an increase in the base rate. The period can be for as long as up to 30 years though invariably everyone is far more familiar with two and three-year terms.

The market's expectations for the future path of central bank interest rates are essentially reflected in swap rates. These estimates consider many elements such as inflation, fuel and food prices, and overall economic conditions. Lenders utilize this rate as well to determine how much to charge for borrowing money to help balance their own supply and demand.

So, when a customer asks about the validity of taking, for example, a two-year fixed rate, they are paying, like a lender, for the privilege of fixing the cost of money and hedging against any movement.

In the current climate, this question of fixing is not as simple as protecting against rises. What is the point of fixing if rates are on a downward trajectory? If money is cheaper and competition more intense, does the borrower have more choices? Well pricing is only one part of the equation, but it is the headline one more often than not. Criteria and affordability still matter.

Naturally, this impacts the remortgage and product transfer market. Brokers will likely face three key questions from borrowers that will influence any course of action they suggest and that clients take.

How do continuing falls in mortgage swap rates affect the products available to me?

Certainty is very often crucial for borrowers, and, as mortgage professionals up and down the country will tell you, fixed rates offer just that. But while fixing in a rising interest rate environment feels like the obvious course of action, when rates are falling, it is not such a straightforward equation. Locking in 5% + in a product period of three or five years may be unnecessary if we are looking at an interest rate environment of 3% two years from now. No one has a crystal ball, but certainty with flexibility may be the order of the day. The long-term look for rates may be benign, and some borrowers may benefit from the flexibility to move without redemption charges if rates continue their downward trajectory.

If you believe interest rates will fall, a tracker could be a great option for clients. Unlike some other variable rate mortgages, it may also be tied to an external rate, such as the Bank of England base rate, so you’re protected if your lender changes their own rates. Some trackers don’t have exit fees, so you could use it for a while before your client locks into a fixed rate.

Should I take a product transfer or look around further?

UK Finance reported that in 2023, the product transfer market grew by 11% to £219 billion. This year, it anticipates that both external remortgaging and PTs will fall away slightly, following a peak in maturing two-year fixed rate deals in 2023. Affordability concerns have not disappeared but may recede as pricing readjusts. On top of that, the new Consumer Duty focus on borrower outcomes suggests that some of the habits of the recent past need revisiting. 2023 was arguably the peak of the product transfer era as many two-year fixed rate deals came to an end at that time. In 2024, brokers need to be ready to discuss and advise on whether product transfers really present the best option after all.

Should we expect to see greater loosening of criteria if the market continues to flourish?

As lenders look to secure market share over the opening six months, expect criteria changes as well as pricing improvements as they look to bolster margins. While pricing may be driven by expectations of future interest rates, flexible criteria offers an alternative method for lenders to accept business – especially while the labour market remains resilient. Over the course of last year, Vida made a whole host of product and criteria enhancements and ended the year with even more rate reductions and two new limited-edition products. The market changes in criteria will often address the gaps many brokers highlight when dealing with clients with light adverse credit.

Brokers are more than capable of moving with the market, and it is beholden upon lenders like ourselves to do likewise to support them and their borrowers. 2024 will not be a repeat of 2023.