Interest rates have beenin a slumpfor months, and lots of us are nowquestioning when they’ll start to rise again in 2021 and going into 2022.There isno way of telling exactly when and what the Bank of England will choose to do to interest rates. Butsavers and borrowers alikecanstart planning for apotentialrisein the near future.
Rock-bottom interest rates have been a common theme during the pandemic.BeforeCovidhit,the Bank of England base ratewasalreadyat a low0.75%. Then in March 2020, the rate was slashed to 0.25% and then slashed againto 0.1%–the lowest the rate has been intheBank of England’s300-plus-year history.
This drastic measure has always been seen asatemporary response to a crisis. But now thatconfidence is returning, albeit with some uncertainty mixed in,many are asking whenrateswillstart to climb againand what borrowers and saversshoulddo to plan.
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How are interest rates set?
The Monetary Policy Committee(MPC)and the Bank of England(BoE)decideinterest rates in the UK.It is the rate that banks use to lend to each other. Whenthe MPC and BoEwant toboost the economy, they set the rate low to encourage the public to spend.When they want tobring down inflation, they increase the rate to encourage saving.
Although banks and lenders are free to set their own interest rates for borrowers and savers,they often use the base rate to guide their decisions.
When will interest rates rise?
The BoE announces the base rate eight times a year, which is about every six weeks.Here arethe key situations that could prompt interest rates to go up:
Inflation increases–If inflation continues increasing at pace,the BoEcould increase the rate to encourage saving.
Economy strengthens–If the economy shows resilienceand growth, this could be a good reason to recover the rate.
Unemployment reduces–Due to policy changes, theunemployment rateis nowconsidered as part of settingtheBoE base rate. Ifunemployment islow, the ratecouldbeincreased.
No one can second guess what the BoE and MPC will choose to do with the interest rate. However, insummer 2021,the BoEindicated that it did notplan to increase the rate until the economic outlook in the UK was more certain.This is because although inflation is rising and expected to continue doing so, the Bank believesthis will slow once post-Covid spending pulls back.
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What do interest rate rises affect and how could that impact people's money?
Until we know when and if interest rates will increase, savers and borrowers should respond to the current low rates and prepare for a potential rise.
Here’s how an interest rate increase could impact the money in people’s pockets.
Savings
Savers tend to suffer when interest rates are low.If the rate your bank offers you is below that of inflation, your savings will losevalue in real terms– and this is the current situation for many savers.
An increase in rate would be good news, as it could mean your savings begin to earn more money than they currently do. If youhave cashin savings, you could shop around for a better rate. They’re hard to come by, but they do exist. Alternatively, you could consider investingto try to beat inflation. There are no guarantees that this strategy will pay off,anda financial adviser can help you choose whichroute best suits your appetite for risk and your savings goal.
Mortgages
If interest rates rise,mortgages will start to get more expensive. People with a tracker mortgage – one that directly tracks the BoE rate – will see an immediate risein their repayments. Similarly, people on aStandard Variable Rate (SVR) will likely see an increase,but this will ultimately depend on their lender’s decision.
Understandably,lots of people are scrambling to lock in a better mortgage deal while rates are low.Just0.5%lowercould knock thousands off the amount you’d pay in interest.
If you’re near the end of your deal,now could be the ideal time to remortgage. Most lenders will let you secure a dealaround three to six months beforeyour current deal ends.A mortgage broker could help you find the optimum deal for you.
But it isn’t always as simple as quitting your deal and jumping ship.If you’re still wellwithinyour deal’stie-in period, you could find yourself paying hefty early repayment charges (ERCs)for switching. For some borrowers,a better dealis worth the penalty.ERCsare calculated as a percentage of your remainingbalanceand they typically reduce the closer you get to the end of your deal. Depending on your deal, thesavings from a newmortgagecould outweigh the fee, but you’ll need to crunch the numbers.
Borrowers who cannot switch deals cost effectively and are worried about the impact of a potential interest rate riseshouldget financial advice. An expert can help you prepare fora changing interest rate, which could involve building up some savings to help you afford higher repayments later.
Small businesses
Interest rates can have a significant impact on businesses that are borrowing cash, whether these are business loans or credit card loans. An increase in rates could see you paying more for your loan, whichwould increase your overheads and put pressure on your cash flow.If you experience cash flow difficulties, additional pressure could impact your ability to attract investors.
There are some ways to help protect your business. You may be able to speak to your bank to fix your interest rateor hedge your product, which involves switching toa fixed dealfor a set period.
It’s also important to assess how your suppliers or customers could be affected by interest rate increases. Suppliers, for example, coulduptheir costs to help cover rising interest, which wouldimpactyour margins.You could hedge against thisriskby increasing your prices or contractually agreeing with a supplier to fixsupply prices, but you should seek advice from an accountant.
Pensions
Your pension pot might growif interest rates rise. This is becausea proportion ofmanypensionfunds are invested in bonds,and the value of bondscould increase if interest rates rise.
Those looking to take out an annuity couldalsobenefit from a higher interest rate. An annuity is an insurance product that offers you a guaranteed incomeafter you retire.Annuity providers will quote you a rateas a percentage,and this percentage of your pension pot is the amount they’d pay you every year.You want to get the highest rate you can. Annuity rates are linked to returns from gilts (government bonds),sorising interest ratescould meanrising gilt yields and increasing annuity rates.
A pension pot is one of the most important savings anyone has, and once you get an annuity, it’s fixed for life – there’s no way of switching. It’s veryimportant to getfinancialadvice before touching your pension.
Interest ratesaffect everyone’s finances. If you have any worries about your savings, loans or your pension, find your perfect financial adviser match on Unbiased.
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