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Funding costs and mortgage rates


Published: 14 March 2012 | Author: Bernard Clarke

Mortgage pricing is back in the news, with some commentators pondering why some lenders have raised borrowing costs while official rates remain unchanged. 

The simple answer is that a Bank rate of 0.5% cannot be taken as a proxy for the costs lenders have to pay for funding. We have published the following information about funding costs, which we hope is useful in explaining some of the issues:

  • Over the course of 2011, overall mortgage rates got cheaper but overall funding costs got higher. The Bank of England has been pointing to the funding pressures for months, most recently in the February Inflation Report.
  • The average rate on new business was 3.55% in January 2011, but had fallen to 3.4% by January this year. On existing business, rates fell in aggregate from around 3.5% to around 3.34% (Bank of England trends in lending data, 29 February).

Chart One: Fixed and variable rates, all mortgages outstanding

Source: Bank of England

  • This is still incredibly low by historical standards – many people will remember paying mortgage rates of 14% or 15% and the average mortgage rate over the past 30 years is 8.35%.
  • Funding costs have risen – the Bank’s February Inflation Report said that, even after some easing of market conditions in January, funding markets remained more difficult than they had been early in 2011. The London inter-bank offered rate (LIBOR) rose from 0.78% to 1.11% over that period, and the rate paid on term deposits to savers rose by around 25 basis points over that period.
  • There is no single proxy for the cost of funds to lenders. They use retail deposits and wholesale funding, and the cost and mix will be different for different lenders and at different times. But it is clear that the direction of travel has been an upward movement in the cost of funds, against a downward movement in rates being charged on the stock of mortgages. This is not sustainable over time so was bound to change. But that does not mean that all lenders will do the same thing – it depends on the individual lender’s funding, and this can vary considerably.
  • For most customers, the rise in rates will be manageable. If rates changed from 3.5% to 4%, monthly payments on a £100,000 repayment mortgage might go up from around £505 to £535, or by £30. Anyone worried about the impact of rising rates should talk to their lender and to one of the independent advice agencies that can help ensure they are taking useful steps to manage their financial difficulties, such as National Debtline, Citizens Advice or Shelter. Most problems can be solved.
  • Many consumers have already been planning ahead for rising rates. Most people understand that the low rate environment that we are currently in is unusual but not permanent. Everyone should be planning ahead to ensure that they adjust their spending to meet their commitments if and when rates rise. Remortgaging to a fixed rate may be appropriate for customers whose financial situation enables them to remortgage but who do not want the uncertainty of future rises in variable rates.