Understanding all the factors that influence mortgage rates as we look ahead to 2025

In the mortgage market, relationships of all types are at the heart of business, but it is important to understand how some of these sometimes complex relationships impact what we do. Financial and economic relationships are an intrinsic part of the mortgage market, and the impact of national and global events can very quickly impact the global cost of borrowing.

Mortgage rates have risen following the Autumn budget when Rachel Reeves announced she would be raising UK taxes by £40 billion, the biggest tax increases in three decades. The new chancellor also changed the government’s fiscal rules to allow her to increase borrowing for public investment by around £50 billion, so what does all this mean for borrowing and why has it affected mortgage rates?

There are several factors that come together to influence mortgage rates, and while a major one is the Bank of England base rate, there are also other market considerations such as inflation, the cost of borrowing, and bond yield risk.
 
The government gets most of its income from taxes, but it also borrows money by selling financial products called bonds. A bond is a promise to pay money in the future and requires the borrower to make regular interest payments. UK government bonds are also known as gilts and are regarded as one of the safest forms of investment because it is thought to be very unlikely that the government will not be able to repay the money. Bonds or gilts are mainly bought by financial institutions both in the UK and abroad, such as pension funds, investment funds, banks and insurance companies. 

In the wake of the recent budget there was a degree of anxiety in the air as the interest rate, or gilt yields, started rising. The yield is the rate that the government must pay lenders when it borrows money. When a yield increases it is a sign that investors see it riskier to lend the government money. This is important as not only does it mean that the government will have to pay more to borrow, but bond yields are also used as a guide for setting the rates on loans and mortgages.

Since the October budget, The Bank of England has cut interest rates to 4.75% from 5% in a move that was widely expected. Interest rates and bonds often move in the opposite direction, in other words when interest rates rise, bond prices usually fall and vice versa.

Interest rates are used to control inflation, higher interest rates bring inflation down as it influences what people spend their money on. Higher payments on mortgages and loans mean that people are left with less disposable income to spend on other things, which in turn affects how businesses set their prices.

While it is difficult to predict exactly what will happen to interest rates over the forthcoming months, the indication is that any future cuts will be slower than what was previously thought, as the expectation is that Rachel Reeves budget will bring with it an increase in inflation next year.

Decisions to raise a cap on bus fares, hike vat on private school fees and an increase in employers’ national insurance contributions, are all likely to boost inflation. That along with a 6.7% hike in the national minimum wage, means that employers are facing rising costs and now there is uncertainty as to how they will respond.

Labour did pledge to not raise taxes for working people, however it has significantly increased costs for employers, and it is thought that this could have a knock on effect on employees, with the wage bill being where many try to claw back some of their new expenses.

While a slower pace of interest rate cuts is better for savers, it means bad news for mortgage borrowers, who now face the prospect of higher mortgage rates for longer, as well as the looming prospect of household budgets being squeezed even tighter over next couple of years.

Mortgage rates are still much higher than they have been for the past decade, and since the budget The Office for Budget Responsibility (OBR) is projecting that average mortgage rates may increase from 3.7% to 4.5% over the next three years as result of the increased government borrowing. 

Latest house prices also show that the average UK house price reached £293,999 in October, which is a 0.32% monthly increase and a 3.9% annual rise. All these factors combined create the perfect storm in terms of affordability challenges for both first-time buyers and homeowners wishing to remortgage.

More than eight in 10 mortgage customers have fixed rate deals. While this may not be an immediate concern for borrowers who have just entered a fixed rate deal, it is going to impact new buyers and those whose fixed rate is coming to an end.

Fixed rate mortgage pricing is based on Sonia swap rates, which is an inter-bank lending rate that is based on what markets think interest rates will be in the future. They can be on one, two, three, five and 10 year terms and the cost is used to price mortgage products for lenders. 

Swap rates are based on assumptions of what interest rates will be over a given period. When swap rates rise, it invariably results in fixed mortgage rates going up and vice versa, when they come down, so will the fixed rate mortgage pricing. Like government bond rates, they react to future expectations of the cost of borrowing. Trump’s election has put further pressure on bond prices in the US and subsequently on UK bonds as investors take their preferred options. This impacts swap rates and ultimately interest rates that try to manage the inflationary impact of the rising costs of debt.

Post-budget, there was a spike in swap rates and this volatility has continued despite the Bank of England’s recent base rate cut. If expectations are confirmed and inflation does rise next year, this increase will be immediately reflected in swap rates, making fixed rate mortgages more expensive.

Understanding swap rates, what impacts on them and what is likely to happen to them in the future is useful for everyone who speaks to clients. It adds real value to understand not only what is possible in the here and now but what is likely over the coming 6 to 12 months so clients are as informed as possible and choose the product that suits them not only now, but also in the future. 

Rachel Reeves budget has certainly got everyone’s attention, albeit some might say for the wrong reasons, and although we are yet to feel the full economic impact of these new budget measures, it is important that everyone understands all the factors that are influencing mortgage rates as we move into 2025.