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Interest rate hike and what it means for your finances

18/05/2022

Creditfix > Blog > Cost of living crisis > Cost of living updates > Interest rate hike and what it means for your finances

 

The Bank of England has raised the interest rate to 1% for the first time since 2009 in an attempt to curb rising inflation.

It was slashed to 0.1% in March 2020 as the country was plunged into lockdown but has been creeping up since December 2021 with soaring inflation prompting the latest 0.25% increase.

So, what does the biggest interest rate jump in 13 years mean for your finances?

In this article, we’ll explain what the base rate is, why the base rate has increased, what it means for your finances, and what you can do about it.

 

What is the base rate?

It is no secret that the cost of almost everything has risen sharply in the past year, and this has sent the rate of inflation soaring. In a bid to slow inflation, the interest rate, also known as the bank rate or base rate, has been increased to 1%.

In the UK, the base rate is the rate at which banks borrow from the country’s central bank (the Bank of England) with a higher base rate triggering a lower inflation rate and vice versa. It determines the interest rate lenders charge on financial products, such as loans and mortgages, and can make borrowing more or less expensive.

It is the most important interest rate in the UK and can have a direct influence on savings, mortgages, pensions, credit cards, and loans.

 

Why has the base rate increased?

The Bank of England increased the base rate to 1% just weeks after the inflation rate was stretched to 7%, the highest since 1992 when it stood at 7.1%.

With the economy already bracing for double-digit inflation before the end of the year (it has already jumped to 9%), it is hoped raising the base rate will halt inflation and encourage consumers to borrow less and save more. If successful, demand should drop, prices should plummet, and inflation should slow.

But it isn’t just the UK experiencing unprecedented price hikes with global inflation contributing to a spike in interest rates around the world. In the same week, for example, India raised its interest rate for the first time since 2018 to 4.4%, Australia’s interest rate budged for the first time in over a decade to 0.35%, and the US underwent its biggest interest rate jump in 22 years to a range of 0.75% to 1%.

 

What does it mean for your savings?

This month’s interest rate hike could be both good news and bad news for your savings with inflation and interest, in theory, in an inverse relationship (moving in opposite directions). This means that when interest rates are low, inflation tends to rise and when interest rates are high, inflation tends to fall.

If you deposit £1,000 into a savings account with a base rate of 1% and an inflation rate of 7%, for example, you will still earn £10 in interest within a year but because the inflation rate is higher than the interest rate, your money will be worth less than when it was originally borrowed.

With research revealing that 19% of UK adults have less than £100 in savings and the cost of living crisis having a devastating impact on peoples’ finances, however, millions of households are struggling to save even the smallest amount of spare cash.

 

What does it mean for your mortgage?

If you are a homeowner, your monthly mortgage payments could be impacted by the base rate increase with lender revert rates and standard variable rates expected to be the hardest hit.

So, if you have a £130,000 mortgage over 25 years with an interest rate of 2.5%, your monthly payments will increase by £17 from £583 to £600.

The amount your monthly payments will increase by depends on the individual terms of your mortgage, however, with banks and credit unions free to decide whether to implement the base rate increase in full, in part, or even at all.

It is also worth remembering that fixed rate mortgages are only fixed for a limited period (usually two years) and that after this time, your mortgage will be charged at the base rate. This will, more often than not, lead to your monthly mortgage payments increasing.

 

What can you do about it?

The news of yet another price increase might have left you feeling helpless but with further financial surprises on the horizon and the base rate on track to hit 1.25% in June, there are steps you can take to soften the blow.

If you have an adjustable rate mortgage, for example, an estimated £340.56 could be added to your annual mortgage payments. It might still be possible to get a competitive deal on a fixed rate mortgage but with the interest rate expected to keep climbing, you must act quick.

If you have money sitting in a savings account, it might be worth waiting until things settle down before switching with the best interest rates changing daily and only a handful of banks upping their rates in the wake of the latest base rate increase.

In the current economic climate, you must have a financial plan in place to protect your bank balance from any sudden interest rate rises. It could be the difference between you paying the bills on time and struggling to make ends meet amid the current cost of living crisis.

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