How to tell if a mortgage rate is cheap?

Categories: guides | property investment guides

When you are considering whether to invest in a property, if you are not buying in cash, mortgage interest rates will be critical to your decision.

But, how can you know if a buy to let or commercial mortgage interest rate is cheap?

This guide looks at three methods you can use in combination to work this out. Once you understand how to do that, you can use our comparison calculators to get latest mortgage interest rates:

1. Buy to let mortgage comparison table
2. Limited company buy to let mortgage comparison table
3. HMO mortgage comparison table
4. Holiday let mortgage comparison table
5. Commercial mortgage comparison table
6. Bridging loan comparison table

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Looking at the Base Rate

The Base Rate is an interest rate set by the Bank of England. It is important because it is used to control inflation, which is a measure of how the prices of things (e.g. food, materials, fuel) increase over a period of time; and it influences the interest lenders can charge for lending such as mortgages and loans.

If the Base Rate is higher than a mortgage interest rate you are being offered, then you are in a favourable position, because in essence the lender could charge you more.

You may find the interest rate you can get is more than the base rate.  For example, commercial mortgage interest rates may be higher than the Base Rate. This is because there is more risk associated with lending on a commercial property.  The higher level of risk relates to that fact that the demand for commercial premises is lower than, say, for a rental that someone will live in. So, if the lender had to repossess the property, in an extreme circumstance where mortgage payments weren’t being paid, it could take them longer to get back their losses than if they had to sell a house with broad appeal.

Bridging loan interest rates are applied monthly, so to make a comparison with the Base Rate, you would need to annualise the rate (multiply it by 12).

Bridging loans carry even greater risk than mortgages, because the security property is typically not in good condition, which affects its saleability. Therefore, a lender is left with a property that is hard to sell, in a scenario where they have to repossess to recoup a debt. 

Also, with a shorter timeframe to repay typically higher amounts, there is a bigger responsibility on the borrower. This too carries some risk for the lender.

This is why bridging loans are only ever intended to be a short-term solution to bridge the gap between buying the property and taking out a mortgage on it or selling it.

For this reason it is less relevant to compare an annualised bridging loan rate with the Base Rate, as it is usual for it to be significantly higher than the Base Rate due to the risk associated with the borrowing.

Looking at Swap rates

Swap rates are a projection of where the money markets expect the central bank rate, i.e. the Bank of England Base Rate, to be at a future point in time.

If swap rates are tracking up, then the money markets expect the Base Rate to increase. 

Mortgage interest rates are strongly influenced by the Base Rate. If the direction of travel expected for the Base Rate, as projected by swap rates, is upwards, then it is likely mortgage interest rates will go up.

If swap rates are largely unchanged, then mortgage rates are likely to stay the same. Lastly, if swap rates are trending down, then mortgage interest rates are likely to go down.

When you are assessing how cheap buy to let mortgage rates are, you can see whether the rate you are being offered is lower than the future forecast is, so assess whether better mortgage rates might be available to you in the future, or if rates are rising and you would be in a good position to fix in the offer you have.

SONIA swap rates

When you are researching which swap rate to look at, to see what is expected to happen to interest rates in the future, you need to look for SONIA swap rates.

SONIA stands for Sterling Over Night Indexed Average. It is based on actual buying and selling of overnight indexed swaps for unsecured transactions that have happened using Sterling (the currency of the UK). The rate is given in arrears.

It is not essential to understand this, but the key to takeaway is that SONIA swap rates are what you need to look at, to assess a buy to let mortgage rate you are being offered.

If the mortgage rate you are being offered is fixed for two years, you need to look at trend information for two year SONIA swap rates to see whether they are going up, down or staying the same.

If your mortgage offer is for a five year fixed rate, then you would look at five year SONIA swap rates over time, to see which way they are moving.

A hypothetical scenario to show how this works

For example, if your mortgage offer has an interest rate of 2.5%, and a deal period/initial rate period of two years, then you would need to look at two year SONIA swaps. The following hypothetical scenarios are ways you can assess a two year fixed buy to let mortgage rate by looking at two year SONIA swap rates:

• The SONIA rate is higher and rising: If two year SONIA swap rates are currently higher than the 2.5% you are being offered and have been rising recently, then the deal on offer to you is likely to be favourable over the period you are borrowing.
• The SONIA rate is higher and stable: If the two year SONIA swap rate is currently higher than the buy to let mortgage rate you are being offered and it has remained at about the same level for some time, then the mortgage rate you are being offered is likely to be competitive as the money markets do not expect rates to come down.
• The SONIA rate is higher but declining: If the two year SONIA swap rate is higher than the 2.5% buy to let mortgage you are being offered, but it has been trending downwards for some time, it could be an indication that a Base Rate reduction is expected which could influence a reduction in mortgage rates.
• The SONIA rate is lower but rising: If the two year SONIA swap rate is lower than the 2.5% buy to let mortgage rate you are being offered, but it is rising you may still be better off fixing your rate, as the money markets are expecting rates to rise and as such mortgage interest rates may get more expensive for you if you hold off.
• The SONIA rate is lower and stable: If the two year SONIA swap rate is lower than the 2.5% buy to let mortgage rate you are being offered and it has remained at that level for some time, the 2.5% rate may be a competitive option for you as lenders are unlikely to bring out cheaper rates in a stable marketplace, unless other factors are at play.
• The SONIA rate is lower and declining: In this scenario you may be in a position where mortgage interest rates could be subject to change. Whilst lenders will want their mortgage interest rates to remain profitable, they may also want to be competitive on price to attract business. However, if their loan books are full they could hold back to stem the flow of new business to ensure service levels do not suffer.

The economy is changing all the time, so nothing is ever guaranteed, but this is one of the three ways described in this article on how to tell if you are being offered a cheap buy to let mortgage rate.

Working with a broker who shares updates on this sort of market activity can help you get this information without having to do the research yourself.

Be aware though that a mortgage advisor cannot give you financial advice – i.e. whether or not to invest. They can only present to you facts about the marketplace that you can use to inform your decisions, their advice is restricted to mortgages only. If you are unsure, you can work with a financial advisor to get their help.

Looking at inflation and ‘real’ interest rates

The third way to gauge if you are being offered a cheap buy to let mortgage rate, or not, is to take a look at the current rate of inflation and calculate your ‘real’ interest rate.

This calculation is: Current rate – Inflation = Real interest rate

To understand what is meant by the ‘real interest rate’ it’s necessary to know the impact of inflation on the relative value of money and what that means when calculating the real interest rate you are paying on borrowing.

Let’s use a simplified example.

Say you have £100 in savings and you put it into a savings account with a bank, which pays 3% interest per year. At the end of the first year you would expect to have made £3 in interest, and for your £100 to have become £103.

However, as mentioned above, inflation has an impact on the relative value of money, which is to reduce its relative value.

To use an analogy to explain this, think about your current wages compared to what your grandparent’s wages when they were your age. In most cases, the wages your grandparents received were lower than your own. So how did they afford to live? 

Well of course the cost of things (e.g. food, energy prices) was also lower, so your grandparents could buy more for, say, £10 when they were your age, than you could today. The relative value of that £10 was higher at that time.

So, referring back to the £100 described above, if the bank account you had put your savings into paid 3% interest over a year, but inflation was 2% for the year, then whilst the figure in your bank would show as £103, its relative value would be £101, and you would actually only get 1% benefit (£1) on your £100.

When applying the “real interest rate” principle to a mortgage interest rate you are being offered, you can assess if it is a competitive deal or not.

Say the mortgage interest rate you are being offered is 2.5% and inflation was 2% you would calculate the ‘real interest rate’ as follows:

2.5% (mortgage interest rate) – 2% (inflation) = 0.5% (real interest rate)

So in real terms you would only be paying a very competitive rate of 0.5% interest on your buy to let mortgage borrowing.

If inflation were higher, at 2.5%, the real interest rate you would be paying would be 0. If it were lower, at 1.5% then the real interest rate would be 1%.

Mortgage rates and criteria

The one key thing you have to remember when looking at tables of mortgage rates is this; a rate comparison table will give you the lowest buy to let mortgage rate based on the limited information you give it.

It cannot tell you whether the property you want to borrow against, your financial circumstances or your requirements from the mortgage can all be fulfilled by the product that is returned as the lowest rate.

Whilst everyone would like to think they should be eligible for the lowest rate available, because (for example) they don’t have poor credit, or because they are investing in a property they perceive as suitable security, this may not be the case.

There are lots of ways a property or your wants and needs may not result in the lowest rate being achievable for you or in fact what you would want.

Talking to a broker can be invaluable in getting this right, so call our team today on the freephone number above to get started.