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What Does an Interest Rise Mean?

Updated on September 23, 2017

Inevitably, there is a lot of uncertainty regarding interest rates in the UK and whether they will rise. A member of the Bank of England’s rate-setting committee has fuelled speculation that interest rates could rise as soon as November 2017 so the current record low rate of 0.25% could soon rise according to recent macroeconomic forecasts. But there is some uncertainty that in some quarters, a modest rise in interest rates could cause hardships for certain households in the UK.

The reason to why there is so much interest in what happens to interest rates is the fact that when they rise, the impact will be felt by more or less everybody living in Britain. Those with any form of debt will be affected, especially those with mortgages. Businesses, the backbone of the economy, will also suffer from higher business loans to fund new start-ups and there will be an increase in the cost of borrowing.

It is estimated that of household spending, more than a third of their income on mortgage repayments is around about one million, meaning that just one in ten households with mortgages experience this. As of when interest rates start to rise, this figure of 1 million is set to increase to 2.3 million, meaning one in four households with mortgages will also experience the same circumstance.

As far as people with mortgages who have switched to fixed rate mortgage deals, these last few years have seen a more significant shift towards fixed rates. Although this is not necessarily an individual’s preference, it is prudent to seek professional advice on these matters.

How does the BofE assess interest rate changes?

The BofE (Bank of England) base-rate affects a host of financial products from mortgages to savings accounts as well as pensions. But it is important to consider such changes in the base-rate and how it comes about.

The BofE MPC (Monetary Policy Committee) undertakes a thorough assessment of the British economy each month; in which they observe a range of demand/supper-side indicators both from the UK and other countries. They then consider the position of the economy and the nature and strength of the inflationary pressures that are forecasted to exist over the next two years. The MPC sets an interests rate that it judges will enable the inflation target of 2%-+1% as established by the government to keep target monetary stability.

How would a base-rate increase affect homeowners?

Essentially, it would result in higher monthly repayments for millions of individuals across the UK who have opted for a variable rate mortgage.

But with a fixed-rate mortgage, it protects against any changes to the Bank of England (BoE) base-rate; and as a result, could prove to be beneficial if the base rate rises. However, if the base rate falls, you are unable to experience any benefits as such per the terms of your fixed-rate mortgage agreement.

A lender will allow you to arrange a longer fix of up to five years on your mortgage or beyond for a slightly higher rate. This will then ensure you against interest rate fluctuations for a more extended period. In a sense, a fixed-rate mortgage is a more slightly different type of educated gamble but a fixed monthly payment for a set period can help with budgeting and can offer extra security for a homeowner. Variable rates are often seen as riskier due to the characteristic in which its rate is floating and can depend on the state of the economy; however, it can be seen as hugely beneficial if the term agreed upon allows the rate to be kept relatively low across the term period.

Homeowners with mortgages on a variable rate should ensure that there is a buffer in place as a safeguard so that they can cope with an increase in their rate. For example, Barclays has a two-year fix priced at 1.14% until the end of October 2019, for those borrowing at more than 50% of their property’s value. The longest fixed rates for existing Barclay’s borrowers have a ten-year fixed period; in which it the price is set at 2.39% until the 31st of October 2027. So it is important for potential homeowners to carefully consider the terms of the mortgage as well as observe the current state of the economy before selecting a mortgage.

How would a base-rate change affect savers?

Interest rates have been at its lowest since the founding of the BofE (Bank of England) in 1694. Although there are pressures to raise interest rates to compete with the inflation rate, the MPC (Monetary Policy Committee) has narrowly kept the base-rate at 0.5% since March 2009 to which they have reduced it further to 0.25% as of early August 2016.

However this decision to do so has left savers to suffer from sunken rates, leaving little incentive for consumers to put money in the bank to accrue value. Easy-access rates have sunk so low that your savings value will essentially erode as it cannot compete with the rate of inflation, but some high street banks are just 0.01% if you put your money in their accounts.

It is said traditionally that savers mostly outnumber borrowers by at least seven to one, so banks are keener to increase interest rates and pass it onto those with high street banking to help pursue their profit margin. So if the BofE increases the base-rate, it is more likely to work in their favour. Despite offering such abysmal rates, more than eight out of ten customers remain loyal to banks in the UK meaning that until consumer behaviour begins to alter significantly, banks are unlikely to offer better rates for everyday bankers as there is little incentive to do so.

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