Swap rates are the market-based reference points used to price the majority of fixed-rate commercial real estate loans in the UK. When a lender quotes you a “5-year fixed rate,” they typically arrive at that number by taking a base benchmark—the SONIA swap rate—and adding a credit spread.
An interest rate swap is a financial contract where two parties exchange interest rate payments. In the context of commercial lending, a SONIA swap rate is the fixed interest rate that the market is willing to exchange for the floating SONIA (Sterling Overnight Index Average) rate over a specific term (e.g., 3, 5, or 10 years).
The Swap Curve: This is a graphical representation of swap rates across different maturities. A “steep” curve means the market expects rates to rise significantly; a “flat” or “inverted” curve suggests expectations of stable or falling rates.
SONIA vs. LIBOR: As of 2021, SONIA has completely replaced LIBOR as the primary benchmark for sterling markets. All new fixed-rate commercial mortgages are now priced off the SONIA swap curve.
Most commercial lenders do not “bet” on interest rates. Instead, they hedge their fixed-rate loans using swaps to ensure they maintain a consistent profit margin.
Direct Pricing Impact: If the 5-year swap rate jumps by 0.25%, your 5-year fixed-rate quote will likely jump by the same amount almost instantly.
Gilt Divergence: While swap rates and Gilt yields (UK Government bonds) generally move together, they can diverge. Some lenders price off Gilts, while others price off Swaps; knowing which your lender uses is key to timing your rate lock.
Hedge Costs: For floating-rate loans, the cost of “Interest Rate Caps” (insurance against rates rising too high) is directly influenced by the volatility and level of the swap curve.
Lenders follow a transparent “building block” approach to determine your final interest rate:
Step 1: Select the Tenor: The lender matches the swap rate to your desired fixed-rate term (e.g., a 5-year swap for a 5-year loan).
Step 2: Add the Credit Spread: This is the lender’s margin, which accounts for the risk of the property, the market, and your track record as a sponsor (typically 2.25% to 3.50%).
Step 3: Account for Structure: Fees, amortization style, and whether the loan is non-recourse can add small adjustments to the final “all-in” coupon.
No. The Base Rate is set by the BoE and affects overnight borrowing. Swap rates are set by the market and reflect what investors think the Base Rate will average over the next several years.
It depends on the lender. Life insurance companies often price off Gilts, while CMBS and challenger banks often use SONIA swaps. We can help you identify which benchmark applies to your specific term sheet.
Yes. Most lenders offer “Rate Locks” or “Forward Starts,” though these may require a deposit or a slightly higher spread to account for the lender’s risk in holding that rate.
Not directly. Floating loans are typically priced off the Daily Compounded SONIA rate. However, if you are required to buy an interest rate cap, the price of that cap is determined by the swap market.
