How Banks Set Mortgage Rates
The way in which lenders set mortgage rates is pretty complex. Every bank or building society that offers mortgages has its own way of setting its mortgage rate or rates.
Factors lenders take into account when setting the mortgage rate include:
The bank rate: Mortgage rates are only loosely linked to the current bank rate because lenders must consider likely bank rates across the lifetime of the loan. Currently, the cheapest fixed mortgage interest rates are close to bank rates but standard variable rates are much higher.
The lender’s funding sources: How the bank or building society sources the money it lends out as mortgages and the cost of it. This may be from their own savers’ deposits or from another source.
The lender’s required margin: The profit margin that the organisation requires or needs on its lending. This policy is likely to be decided by its directors.
How competitive the lender wants to be in the market: If a bank wants to originate more mortgages and grow their loan book they are likely to offer a more competitive rate compared to other lenders, and vice versa.
Other factors taken into account when setting the mortgage rate are linked to the type of mortgage and how the bank or building society sees the risk it involves.
The type of property: For example, whether it is a residential property to be lived in by the borrower, a buy-to-let property, a commercial property or some other kind. Interest rates on standard residential mortgages tend to be lower than other types.
The type of interest rate: Whether it is a fixed rate mortgage, a variable rate mortgage or perhaps a tracker mortgage. A fixed-rate mortgage is fixed for a number of years, typically one, two or five years.
The loan to value and the amount of the mortgage: Lenders may set different interest rates for smaller and larger mortgage advances. They will also often have different rates for how large the mortgage is in relation to the value of the property, known as loan to value or LTV.
The credit status of the borrower: Lenders will consider things such as a borrower’s employment, income, outgoings and their record of repayment (or default) on other credit they’ve had. Borrowers who are seen as less risky may be offered a lower interest rate mortgage than those who are seen as more risky. Limited companies may be charged a higher rate than individuals.