Kicking off 2024 with a rate war, lenders showed they meant business this year — much to the delight of borrowers and brokers.
Now, the question on everyone’s mind is whether rates will continue to fall.
While the rate cuts we have seen so far can be attributed to falling swap rates and the anticipation of interest rate cuts later in the year, what appears to be playing just as big a role — if not bigger — is lender competition.
This time of year is when lenders want to get their pipeline off to a strong start
The onset of a new year usually reawakens lenders’ competitive side as they plan to meet their lending targets. However, this year, more than ever, discounts have been substantial. While the average two-year fixed rate sat just above 6% at the end of 2023, at the time of writing it is around 5.56%. Similarly, the average five-year fix, which ended the year around 5.65%, is now edging closer to 5%, at 5.18%.
The fact that January’s surprising uptick in inflation did not inhibit lenders’ rate cuts suggests that competition is playing a large part in driving down rates.
So, what can the market expect over the course of 2024?
Volume is king
“The current rate war is down to a combination of reduced cost of funds, as the market anticipates lower interest rates in the future, and lender appetite,” says SPF Private Clients chief executive Mark Harris.
“Even though lenders could source their funds in different ways, they are all affected by how their peers around them price, and act accordingly.
They need to start on the front foot, all pushing to secure top spot in the best-buy lists
“Banks are businesses, so hitting targets, whether lending, return on investment or profit, is important. Swaps edged upwards very recently on the back of the surprise higher inflation figure but lenders kept reducing costs, which could indicate that volume is king. Lenders don’t make money if they are not lending it,” he adds.
JLM Mortgage Network group director Sebastian Murphy believes that, with gross lending having fallen by almost a third in 2023 compared to 2022, lenders will be doing all they can to win business.
“Lenders have significant lending targets for the year ahead and they need to start on the front foot, all pushing to secure top spot in the best-buy lists. They need to start lending again if they are not to start reducing costs by shedding staff, etcetera,” he warns.
“The easiest way to boost lending, even if the market does not bounce back, is for a lender to try and increase the size of its slice of pie. And the easiest way to achieve this is by increasing market share by reducing rates.”
Specialist mortgages and secured loans have an added element of risk, a heavier default risk
The pressure on lenders to compete for business is unlikely to ease in the short term but what about the other part of the puzzle — swap rates and the Bank of England (BoE) base rate?
“At the moment, lenders are utilising the funds they secured in December when swap rates reached their lowest points for a considerable time,” says Murphy. “That has meant a large number of rate cuts, but we would anticipate this plateauing now for a couple of months.
“Swaps inched up again in January, and we may well need to see bank base rates being cut in both Europe and the US in order for that to feed in to our swaps. In this scenario, we may not be looking at any big cuts in rates until March.”
‘Sharpening of the pencil’
However, MT Finance managing director Gareth Lewis thinks intense lender competition could produce more rate cuts.
“While lenders are trying to get business through the door, we may see a sharpening of the pencil when it comes to rates in the coming weeks,” he says. “It also depends on how swaps play out as many lenders are Sonia funded rather than base-rate funded, so if there is a downwards trend they could pass this on to borrowers.
Some lenders may get a bit more aggressive by playing around with rates to fill their coffers
“It could be interesting because lenders may decide to play it safe and stay where they are. A lot depends on how much competition there is in this space; if there is less, there isn’t such a need to be aggressive when it comes to pricing. There won’t be a sudden rush to go down the pricing curve.”
Harris, too, believes that the direction in which rates turn will be largely dependent on lender competition.
“Mortgage rates are likely to continue their downward trajectory this year,” he says. “They may plateau as and when lenders hit their lending targets.
“For swap rates to fall significantly, the market would need some sort of trigger such as worsening economic news, a rapid fall in inflation, or noises out of Threadneedle Street suggesting base-rate cuts ahead. Then we could see further reductions.”
Opinion is divided on how much the BoE base rate could fall this year, with predictions ranging from no cuts to four.
BTL or high-net-worth pricing can be different from residential, where risk is a factor. The less risky the lend, the lower the rate
LiveMore Capital chief executive Leon Diamond expects cuts in the base rate but not any rapid movement.
“Given the macro-economic climate, BoE rates should come down,” he says.
“Interest rates are pointing lower and the economy is showing signs of stress, with growth coming in near flat below 1% for 2024.
“Historically, the BoE has been slow to alter base rates. For example, when it was slow to raise them in 2022, we saw inflation spike out of control and peak at 11.1%.
“In 2024, I expect the BoE will continue to be behind the curve and slow to cut rates. This will cause more economic headwind and pain in the UK economy,” adds Diamond.
He says the charts to watch are UK swap or gilt rates; less so the base rate because most mortgages are set to a fixed period, which is derived from the matching swap duration.
Elements of the specialist sector are funded in different ways
“Lenders typically price off the UK swap curve and their cost of funding. As inflationary expectations have reduced and concerns about the economy have impacted the market, we have seen investors buy UK gilts and lower the yield. Therefore, lenders have been able to reduce rates.”
How the sectors differ
One area where many will be hoping for a reduction in rates and fees is the buy-to-let (BTL) sector.
“As rates fall, we would expect fees to normalise in the BTL market, with those higher percentage fees of 7%-plus to disappear,” suggests Harris.
“BTL or high-net-worth pricing can be different from residential, where risk is a factor. The less risky the lend, the lower the rate.
“A 75% BTL lend to an experienced landlord is deemed a safer bet than a 95% loan to a first-time-buyer [FTB] because capital adequacy rules dictate that a lender must set more capital aside for riskier lending; hence it is more expensive.”
Although some BTL deals may be deemed less risky than FTB deals, BTL rates do not appear to have reduced at the same pace as residential, so far.
JLM Mortgage Network founding director Rory Joseph thinks this comes down to funding.
Given the macro-economic climate, BoE rates should come down
“The majority of BTL lenders have to buy warehouse money to lend. As a consequence, the high-street/balance-sheet lenders, which also operate in this space, don’t have to be as competitive as they need to be in the residential space,” he says.
However, he does believe that lenders will continue to be more flexible in their underwriting over the coming year.
“There is cause for optimism that 2024 will see BTL get going again,” he says, “especially with the rising levels of rent that are being seen in this very squeezed market.”
As well as reduced pricing, we may see increased incentives from lenders — particularly in the bridging sector — in a bid to attract business, suggests Lewis.
“Some lenders may get a bit more aggressive by playing around with rates to fill their coffers, as well as offering free legals and valuation refunds,” he says. “This time of year is when lenders want to get their pipeline off to a strong start and have a spring in their step, so there may be more incentives on offer.
It could be interesting because lenders may decide to play it safe and stay where they are
“Ultimately, every lender has a desire to get money out of the door in the best way it can. If you take bridging as a whole, there is no unique nature to it and there isn’t a lot of innovation in terms of new products. A common-sense approach to lending is essentially what bridging is, and certainty, sticking by what you say, etcetera, are the key factors clients are looking for from a bridging lender.”
Likewise, other areas of the mortgage market can carry an extra layer of risk, which can at times separate them from the residential market in terms of pricing.
“Specialist mortgages and secured loans have an added element of risk, a heavier default risk, which is connected to domestic risks rather than the global economy,” says Brilliant Solutions managing director Matthew Arena.
“These connect to employment, cost of living and the housing market.
“While these risks affect every market, the specialist sector is far more exposed to changes in demand as a result of the greater risks. With changes in demand comes a requisite change in margin to generate interest in the product.
Lenders don’t make money if they are not lending it
“We shouldn’t see this change materially in the next few months or for the year ahead, so interest rate reductions elsewhere should be passed on into the specialist sector.”
Arena adds: “Elements of the specialist sector are funded in different ways. For example, a lot of commercial term lending is variable rate based, so it’s often Bank base rate plus margin. The margin (or loading) is the required rate of return for the lender. Swap rates and five-year fixed rates have only a small impact in that market; though fixed rates are available.”
What next?
In a fast-paced market, predicting what will happen next is challenging. However, all the signs point to a competitive year ahead for pricing.
At this stage, further interest rate hikes seem unlikely, which should keep the cost of funding relatively stable.
There are, of course, inflation concerns, as well as threats from events on the global stage, which are ever present.
Lenders are all affected by how their peers around them price, and they act accordingly
Lender appetite, at least for the first half of the year, should ensure that rates are kept competitive. The mortgage market benefits from almost 80 lenders, most of which will be competing for business and looking to meet their targets.
Notwithstanding any major new events either at home or abroad, this competition should prevent significant increases in mortgage rates.
If anything, we may see further cuts.
This article featured in the February 2024 edition of MS.
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