The London Interbank Offered Rates (Libor) is a benchmark interest rate that a number of the world’s leading banks charge each other for loans. It is set by market forces representing $450 trillion of deals and used to price financial contracts.
Every day the largest banks submit the interest rates they are willing to lend to other banks based on a number of currencies and other different periods of time. The highest and lowest quartiles are discounted and an average is calculated for the remainder.
One of the main sources of mortgage lending is borrowing from other banks so Libor has an important part in setting mortgage interest rates. Many commercial and buy-to-let mortgages directly track Libor although most residential mortgages track the Bank of England base rate.
Another important benchmark is the swap rates and these influence the fixed mortgage rates. Banks take deposits and pay a variable or floating interest rate while offering fixed rate mortgages.
This exposes the bank to a risk which they can hedge by swapping the funds raised through variable rates with fixed rate funds from other banks. These swap rates react to expectations of future interest rates and inflation, which affect the price of mortgages.
The attractiveness of fixed rate mortgages depends on how they compare to variable rates. When fixed rates are lower than variable rates demand is strong and when fixed rates are higher than variable rates demand is weaker.