The bank didn’t raise rates, so why are mortgages 6%?
The same fears driving 30-year gilts above 6% have pushed the average fixed-rate mortgage to 6%, but the upcoming Budget can only ease worries about Britain’s issues.
In early September, about 1,500 different fixed-rate mortgage deals had interest rates below 5%. By the 5th of October, only nine were left. Over the same period, the Bank of England kept the Bank Rate at 3.75%, yet the five-year fixed-rate mortgage has climbed to 6%. If the bank didn’t raise rates, then who did?
How are mortgages priced?
Fixed-rate mortgages are priced off swap rates, the wholesale cost of swapping a floating interest rate for a fixed one over a set number of years. A typical 5-year fixed rate is equal to the 5-year swap rate plus the lender’s margin. The swap locks in a rate, so it reflects what the market expects the Bank Rate to do over that period.
By late September, the market had already priced in about an 80% chance of a November raise and four hikes by mid-2027, implying that the market expects the Bank Rate to increase four times within the next year. This means that borrowers face higher mortgage rates before any anticipated Bank Rate increase takes place.
The UK vs the world
The expectation of rising rates is a global issue. The war in Iran has kept oil prices elevated, reviving inflation fears. Consequently, yields have been rising globally in countries like France, Germany, the US, and Japan. However, Britain’s issues are seemingly more pronounced than everyone else’s. As of 13th October, the UK had the highest 10-year yield among major economies at 5.44%, above even the US at 5.22%. Beyond inflation fears, pension schemes are also no longer buying long gilts, leaving the market to buyers who require more compensation for risk.
Additionally, in September, the Bank of England stopped its sales of long-dated gilts. In the past, defined-benefit pension schemes were the most common purchasers of long-term gilts because their liability periods also last decades. However, most defined-benefit pension schemes are closing to new members, and many are de-risking or transferring to insurers through buyouts. Now, hedge funds and overseas investors are the main buyers left. These price-sensitive buyers weigh gilts against global alternatives for the best chance of profit given their risk tolerance and will buy only at a yield that compensates for the risk.
The 30-year gilt is priced a bit differently because, over 30 years, Bank Rate expectations generally matter less. Rather, the term premium matters more as investors demand more for lending over longer periods. This can also be read as how much investors trust the government. With fewer committed buyers for these gilts and doubts about public finances, investors are generally asking for higher premiums due to lower trust.
So, this issue started abroad, but it is now amplified in the UK.
Who feels this rise
Two main groups will be affected: first-time buyers and the 1.8 million fixed deals set to expire this year, as estimated by UK Finance.
For first-time buyers, Lloyds puts the typical first-time buyer home at £239,681. With a 10% deposit, a loan of ~£216,000 remains. On a 25-year mortgage at the average 5-year rate of 4.91% from January, that is about £1,250 a month. Today, at 6%, the monthly payment goes up to £1,390. That’s a difference of £140 a month or £1,680 a year.
Even with these numbers, a mortgage is generally still more affordable for a typical first-time buyer. Lloyds found that rent is 41% of an average renter’s income, while a mortgage is around 34% for the typical first-time buyer. But the real barrier for young people is saving the ~£24,000 deposit while also paying rent.
Of the 1.8 million fixed deals set to expire, ~750,000 households are currently on rates under 3%, according to the Bank of England. So, the refinancing shock of rates at least doubling is also a key issue to consider.
On Wednesday 28th October, Chancellor of the Exchequer John Healey will deliver his first Budget, with new Office for Budget Responsibility (OBR) forecasts published the same day. In March, OBR gave £23.6 billion headroom against the fiscal rules. But EY estimates it has roughly halved to around £11.3 billion, mainly because higher gilt yields mean higher debt interest costs. In EY’s downside scenario, where oil prices stay high into 2027, it drops to a £7 billion deficit. Ultimately, Healey’s budget, followed by the Bank of England’s decision on the 5th of November, will be a key determining factor on whether lenders will continue to reprice upwards.
