What happens to mortgages if the base rate goes down?

In the midst of the credit crunch, the cost of mortgages has become an increasing concern for both existing and would-be homeowners. Since the sub-prime mortgage crisis caused panic for banks across the globe, lenders have been extremely careful not to take on any more ‘risky’ debt – which has meant tighter lending criteria – and they have also been keeping interest rates on mortgages relatively high.

The recent base rate cut to 4.5% was aimed primarily at encouraging lenders to offer lower interest rates on their mortgages and other credit products. However, as with the previous base rate drop, a number of lenders were reluctant to pass on the base rate cut to their SVR mortgage products.

The key measure of the way banks respond to base rate cuts (and other external influences) is LIBOR (the London Inter-Bank Offered Rate). This shows the average rate at which financial institutions are lending to each other – a key source of funds for loans and mortgages.

Last week, LIBOR stood at 6.21% – down from 6.249% – but at over 1.7% higher than the base rate, it has still shown that banks are reluctant to borrow from each other, and when they do, it is expensive.

There are two main factors affecting LIBOR here: the base rate is one, since it does make borrowing funds cheaper for banks – but the other is lender confidence. Most lenders are currently uncertain about the future, and more relaxed lending might seem too much of a risk to take at this time. 

But if the base rate drops further, thus increasing the amount of ‘profit’ banks can make from lending, we may see banks begin to ease up and lending return to higher levels.

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