Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
The Bank of England is expected to increase rates once again at its meeting this week, with the markets expecting interest rates to rise to 0.5%. What’s more, they expect three more increases this year, meaning that by Christmas 2022 we’ll have a base rate of 1.25%, if the expectations are to be believed.
Even a 25 percentage point increase to 0.5% this week will have a big impact on some people’s finances, with mortgage rates shooting up for those on variable rates and debt getting more expensive. Savers will get a boost from any increase, but it’s unlikely to be very dramatic. In November last year, before the last interest rate rise in December, the top easy-access savings account was 0.65% and now it’s 0.71% -- meaning banks passed on less than half the 15 percentage point increase in the last Base Rate rise. Savers will have to get savvy with their money if they want to benefit from higher rates.
Your mortgage will get more expensive
Anyone on a variable rate mortgage will see their interest rates go up – mortgage companies are very quick to pass on the Base Rate hike. A shift from the current 0.25% up to 0.5% will mean someone with a £250,000 variable rate mortgage* will pay an extra £384 a year. With higher borrowing of £450,000 the increase in costs is more dramatic, with those homeowners having to pay an extra £684 a year.
The current market expectations are that the base rate will rise a total of four times this year, taking it to 1.25% before the end of 2022. If this is the case, homeowners with £250,000 of borrowing will have to pay an extra £1,560 a year, or £130 a month, while those with £450,000 of borrowing will have to find an extra £2,808 a year.
One option is to fix your mortgage now, so you lock in current rates and avoid an interest rate rise. Mortgage companies have already started to increase their rates, and they’ll rise again once a rate rise actually happens. Someone with £250,000 of borrowing on the average variable rate mortgage now could save £2,124 a year by switching to the current top two-year fix. If rates rise to 0.5% they would save £2,892 a year**. If someone wanted to switch for longer they’d save less each year, but more over the term of the fix.
*Assumes a repayment mortgage with a 25-year term, at the current average variable rate of 2.47%, based on BoE figures.
** Assumes a repayment mortgage with a 25-year term, at the current average variable rate of 2.47%, based on BoE figures. Switching to the top two-year fix of 0.99% from Natwest, on 80% loan-to-value. Rate was still available at time of release.
Your fixed-rate savings will look less attractive
Anyone who has already fixed their savings rate will miss out on any Base Rate rise. The top two-year fixed rate account is currently paying 1.62%***, which is significantly more than the top easy-access account of 0.71%. But both those rates could rise after Base Rate increases – and if you’ve already locked in for two years you’ll miss out on any increases.
If you have £10,000 saved and put it in the top two-year fix now you’d have made £327 interest at the end of the two years, but if you wait and Base Rate (and savings rates) rise by 0.25 percentage points, you’d make an extra £51 in interest. If Base Rate rises to 1.25% and all that gets passed on to savings rates you’d make an extra £204 in interest at the end of the two years.
***Based on figures from Moneyfacts, accurate to 31/1/22
Your debt will get more expensive
Anyone with debt is going to really feel the pinch of an interest rate rise, as the cost of borrowing on credit cards, personal loans or store cards could rise. Banks are very quick to pass on any rate rise to customers when it benefits them, so those with debt should be braced for higher costs.
The cost of debt has already risen in anticipation of a rate rise, with average overdrafts interest rates being just under 21% - a record high****, while personal loan interest rates also rose in November to 6.43% -- the highest since pre-pandemic times.
Anyone with debt needs to work out if they can switch it to cheaper borrowing, and get in quick before rates do rise. Look at whether you can transfer credit card borrowing to a 0% balance transfer deal or see if you’re eligible for an interest-free overdraft. After that, people should list out their debt from the most expensive to the cheapest, regardless of the amount owed on each one, and prioritise paying off the most expensive before moving down the list.
****based on Bank of England data: https://www.bankofengland.co.uk/statistics/money-and-credit/2021/november-2021
Your savings might not earn any more interest
While banks are very quick to pass on any Base Rate increases to their mortgage customers, savers will have to wait longer and many won’t see any increase at all. Lots of people’s savings are just sitting in their current account or their old savings account, where the rate is likely 0.01%. And these people likely won’t see an increase in the interest rate they’re being paid, instead banks will pocket the difference to boost their profits.
But that doesn’t mean savers need to miss out, they just need to do a little more work to get a higher rate. After a rate rise we usually see rates edge up and more competition in the best buy tables as providers vie to reach the top, but you’ll have to switch to get a better deal.
Investing still might be a better option
Inflation has soared in recent months and is expected to go even higher. This means that even with interest rates rising, if savings rates rise by the same amount as Base Rate you’ll still be nowhere near beating inflation. The current top easy-access savings account pays 0.71% interest, if Base Rate rises to 0.5% and all of that increase gets passed on to savers then the top account will pay 0.96%. That’s still miles away from current inflation of 5.4%. At those rates if you had £10,000 invested, after a year your money would be worth £444 less in real terms. What’s more, inflation is expected to average 6% over the year, which means it’s going to rise much further from here.
Cash is a great place for short-term savings or money you need quick access to, but it’s not ideal for long-term savings. So, work out what you need in the next five years or as an emergency pot, and see how that stacks up against the amount you’ve got in cash. If you’ve got way more than that set aside, think about investing it.
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