Mortgage Rates Lose Their Dependence on Base Rate

September 7, 2008

Mortgage rates are traditionally linked to base rates. If the base rate goes up then for sure mortgage rates will follow.

What is the “base rate”? Base rate is the annual interest rate on which lending charges are calculated by the banks. It is set by the Bank of England Monetary Policy Committee on a monthly basis. This has been independent of the Government since 1997.

In 2000 the rate was at 6%, but came down steadily, usually by quarter point reductions to reach 4% in autumn 2001. It was stable for nearly a year before going down again, to a low of 3.5% in summer 2003. Spending was under control, inflation was low, the Labour Government was still popular and mortgage rates were low as a result.

From autumn 2003, though, the interest rate rose steadily, again by quarter point changes – this time upwards – to reach 4.75% in summer 2004. There was dip a year later, to 4.5%, and it remained at that level until August 2006. The next twelve months saw five quarter point rises, to bring the base rate to its current level of 5.75% - its highest level since April 2001.

The Monetary Policy Committee tried to keep inflation at or near the government target of 2%, and the purpose of the rises has been to curb spending and keep control of inflation. The theory is that if people are paying more to borrow money, they won’t borrow as much. The Bank has been worried that inflation is on the rise again due to factors like soaring energy costs – these, of course, being out of the control of consumers.

The effect on mortgage rates is almost automatic. Base rate rises are usually passed straight on to consumers – usually in full. The bigger the loan, the higher the rate of interest, the more a mortgage is going to cost each month on a standard variable rate (SVR).

Consumers are left to look for bargains beyond the SVR. More people than ever are looking for fixed mortgage rates, which will keep their payments the same each month for a set period (two, three or five years – sometime more). These tend to be slightly higher than other discounted or tracker type rates, but with interest rates on an upward trend the fixed rate may be lower than those in a short time. Banks and Building Societies have to compete it certainly pays the consumer to shop around.

Recently mortgage rates have been going up despite the base rate remaining at 5.75% since July. The reason for this has been the increasing cost of credit in the financial markets, and the increasing risks perceived by the banks to go with some types of lending. The link between the base rate and mortgage rates is not as rigid as it used to be.

In fact there are more people with savings than mortgages. Financial institutions are not so quick to pass on higher interest rates to their savers as they are to their borrowers, as a result of base rate increase, and often it’s not the full amount. Of course, savings rates are always less than mortgage rates so those with both will suffer the consequences.

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