Are interest rates finally going to start heading upwards? More than six years after the Bank of England took the unprecedented decision to cut its base rate to just 0.5%, as the UK struggled to recover from the financial crisis; top economists believe that a hike will take place at some point in 20161.
Nothing is certain. The UK’s negative inflation rate may give the Bank reason to delay an increase. So might further global economic turbulence – more bad news from China, for example, or new problems in the Eurozone.
The Cost of Mortgages
Homeowners have benefitted hugely from lower interest rates, with cheaper mortgages than even before. In 2008, the best-value two-year variable-rate mortgage was costing borrowers 5.53% a year according to Moneyfacts, the personal finance data specialists; by last year, that had fallen to 1.75% – and rates today remain below 2 per cent2.
That super low cost of borrowing has meant far fewer people have got into trouble with their mortgages, even during the recession that followed the financial crisis. The Council of Mortgage Lenders says just 21,000 people had their homes repossessed last year, the lowest figure since 20063. However, there is now a danger of complacency, with mortgage borrowers assuming that the good times will last forever.
The Money Advice Trust, a Government-backed charity, points out that more than a million borrowers have taken out their loans during the period when rates have been frozen – they will never have experienced higher borrowing costs4.
In fact, research conducted by The Resolution Foundation, an independent think tank, suggests even modest interest rate rises could hit some people very hard.
If the Bank of England base rate were to increase to 3% by 2018 – which would still be very low by historical standards – some 1.1 million households would be spending half their disposable income on mortgage repayments, twice the current figure5.
It’s therefore important to understand what impact interest rate rises would have on you – and to think about how to respond. For example, a 0.5 percentage point increase in the cost of a £250,000 mortgage currently priced at 2.95% a year would add £47 to your monthly repayment. If the cost was to go up by a full percentage point, you’d have to pay £96 extra each month.
The precise impact that interest rate rises will have on your personal finances will depend on how much you have borrowed and what type of mortgage you have.
Broadly speaking, mortgages fall into two categories: fixed-rate loans, where the interest rate you pay is set in stone for a certain period – two, three or five years, for example – whatever happens to the Bank of England base rate; and variable-rate loans where your lender has the right to change the interest rate it charges you.
If you have a fixed-rate mortgage, you won’t be affected by a Bank of England interest rate for as long as your deal is due to last. Variable-rate borrowers, however, almost certainly will be. Some variable rate deals – known as tracker mortgages – automatically move up and down with changes in the base rate, though they usually cost more than the rate the Bank quotes.
In practice, it’s important to take advice about your mortgage options, either from your lender or an independent adviser. You may need help exploring the pros and cons of different mortgage deals, as well as guidance on the potential costs of switching – including any costs you’ll incur to get out of your existing mortgage.
Savings and Investments
Mortgages won’t be the only financial product affected by an interest rate rise – there could also be an impact on your savings and investments, though the exact effects could be harder to predict.
Savers should welcome interest rate rises. The average easy access savings account at the bank or building society currently pays an interest rate of just 0.61% a year according to Moneyfacts, a pretty paltry return6. There is no guarantee that your savings account provider will pass on Bank of England base rates in full, but some definitely will – so it’s important to keep an eye on your money to ensure you’re getting the best possible deal.
About Scottish Friendly
We are a leading UK mutual life and investments organisation that provides investors and their families with a wide range of investment solutions (including Investment ISAs and Junior ISAs). Based in Glasgow, our staff is dedicated to providing the best in customer service. The value of your investments can go down as well as up, so you could get back less than you have paid in. Tax treatment depends on individual circumstances.
1. https://www express.co.uk/finance/personalfinance/612103/UK-interest-rates-forecast-economist-predictions-rise-2016
2. Which? Money’s March 2014 issue, page 11