How do banks set mortgage rates?

Mortgage lenders set their own rates and take a number of factors into account when determining the rate that a borrower pays.

Funding model - lenders can fund their mortgage lending through a number of ways, usually by raising deposits from savers or through accessing the wholesale markets. Lenders also have to consider the cost of regulation, such as capital and liquidity requirements, default rates and administration and marketing expenses.

Type of mortgage ?whether a mortgage is a variable rate or a fixed rate, including the length of any fixed rate period will impact the rate offered to borrowers.

Loan-to-value - the amount someone is seeking to borrow as a percentage of the value of the property is known as the loan-to-value (LTV) ratio. Higher LTV mortgages are more expensive than lower LTV mortgages due the additional risk involved for the lender and the cost of the higher level of capital lenders are required to hold against these higher LTV assets.

Credit history - the credit rating and credit history of the borrower(s) will have an impact on the rate a lender is willing to grant, as a lender has to take into account the risk of default.

Competition in the market - the UK mortgage market is very competitive, and lenders monitor how others are pricing in the market and may adjust their deals in response, depending on their own risk appetite at the time.

Changes in mortgage rates

While a move in the Bank of England base rate is one event that could lead to changes in mortgage pricing, lenders vary the rates they offer to the market on a regular basis and rates can move up or down.

Lenders will amend their pricing in response to changes in their funding costs, both in the retail savings and wholesale markets, as well as considering what sort of borrowers they are targeting at any particular point in time. For example, a particular lender might want to increase the amount of 90 per cent LTV lending it is doing and so seek to offer attractive rates in the market in the hope that this will result in more borrowers applying for them.

As most borrowers are currently on fixed rate mortgages, any increase in the Bank of England Base Rate would not lead to any change in their monthly payment until their fixed rate period expires. Lenders will get in touch with customers towards the end of their fixed-rate deal, if they choose not to secure another fixed rate they will likely revert to their lender's Standard Variable Rate product.

Borrowers on a tracker mortgage would be likely to see their cost of borrowing increase, as almost all current tracker mortgages are pegged to the Base Rate. Mortgage lenders consider the affordability of interest rate changes as part of the underwriting process to ensure a customer would be able to afford their mortgage in case of any price fluctuation.