Why do swap rates matter?
Most homebuyers think that the only rate that matters when it comes to the cost of borrowing is the Bank of England base rate. But the more obscure swap rates can affect the cost of your mortgage too. These are the rates that banks and other financial institutions pay to borrow from each other.
The swap rate is based on the LIBOR rate – the London Interbank Offered Rate. This rate is published daily and is the average interest rate that major banks in the City charge when lending to other banks. LIBOR is used as the reference rate for interest rate swaps.
Lenders may raise funds on the money markets using swap rates. They can then use them to set the level of interest on fixed-rate mortgages as they can fix the swap rate for a set period of time typically between 1-10 years. The rate they pay is based on the likely average rate of swaps over the fixed number of years they've chosen. They then add their margin onto their costs to pass on to their borrowers. Sometimes swap rates work out cheaper than the base rate.
These fixed-rate mortgages sell out fast which explains why some mortgage offers disappear within weeks. Once the funds the lender has raised on the money markets are allocated to house buyers, they cease to offer that rate and may go back to the market to buy more swaps.
LIBOR can also be used for tracker mortgages. The majority of trackers are based on the base rate plus a certain percentage, but some lenders will base it on LIBOR plus a margin. These more sophisticated trackers are few and far between.
