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What does the base rate cut mean for your finances?

On 19 March, 2020 The Bank of England slashed the base rate for a second time in a single month down to a record low of 0.1% warning that the coronavirus pandemic will result in a "sharp and large" economic shock. The Bank of England cut the base rate of interest to 0.25% on 11 March 2020, back to historically low levels seen following the referendum on Brexit in 2016.

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What does the base rate cut mean for your finances?
What does the base rate cut mean for your finances?

The base rate cut will likely lead to mortgage deals becoming cheaper. Savers, however, will lose out as returns from cash savings accounts were already woefully low.

Could you afford your mortgage if your rate goes up?

Use our rate rise calculator to see what could happen to your mortgage repayments.

The base rate had been on an upward trend since it fell to an all-time low in the midst of the financial crisis in 2009. It had stayed at this record low for seven years, and lead to gradually cheaper mortgage interest rates but poor rates for savings deposits.

What is the base rate of interest and why does it matter?

The base rate of interest is the ‘price’ that retail and merchant banks can buy money for. It is set by the Bank of England's nine-member Monetary Policy Committee, who meet every month to vote on whether to change the rate.

The base rate is one of the most significant influences on UK interest rates that are available to the public for both borrowing and savings. In the past, where the base rate has gone, mortgage and savings rates have followed closely. It can also affect the value of the pound.

Watch the Bank of England's video series if you'd like to know more about their role.

Uncharted territory

Historically, the base rate gradually cycles up and down in relation to growth, inflation and other economic indexes. Once the rate began to rise from a low point, it continued to rise for a year or so until it hit a peak, when it would gradually fall.

But, we’ve been in uncharted territory ever since 2009 when the BoE took the base rate to a then unprecedented low of 0.5%. Rates had been trending upward since then, however, the coronavirus outbreak has put a halt to that.

Given the economic crisis stemming from the pandemic and the uncertainty around how long it may last, it's difficult to predict when the interest rate will change again.

What could the base rate cut do to mortgage rates?

For some people existing mortgages should get cheaper, such as those with tracker mortgages or variable rate mortgages. It remains to be seen whether lenders will offer new mortgages based on this new rate, especially given that the mortgage process may not be possible during the lockdown.

Average mortgage rates and the Base Rate of Interest

Lenders set their own internal 'base rate' for customers, called the Standard Variable Rate (SVR), which they will set at their discretion. All of a lender's mortgage deals (other than tracker mortgages) will be based on this rate.

What could this mean for repayments?

Repayments will likely start to decrease for borrowers with mortgages that are on variable rates.

However, the amount monthly repayments will decrease by depends on how their bank responds to the base rate cut and how much they decrease their SVR by.

Those with tracker deals stand to see the most clear and direct drop in their monthly repayments, as these mortgages follow the base rate.

Could you afford your mortgage if your rate goes up?

Use our rate rise calculator to see what could happen to your mortgage repayments.

What could you do with your mortgage?

With mortgage rates dropping after the rate cut it could be tempting to remortgage to get a fixed rate deal at a lower rate.

However, if you are considering switching to a new mortgage make sure you carefully examine any exit fees you may have from your existing mortgage as well as looking closely at booking and arrangement fees for a mortgage.

These fees might not make it worth your while to switch mortgages, but if the new rate you are switching to is significantly lower enough you should soon see some big savings.

As a general rule, you should also approach your mortgage with a personalised plan, ignoring the markets to some extent, or you could find yourself obsessing over getting the perfect rate and missing out on perfectly suitable deals.

Switch to a fixed mortgage rate

fixed rate mortgage will give you set a set rate (and fixed monthly repayments) for a number of years, typically between two and five years, but sometimes as long as 10 years.

Despite offering security, switching to a fixed rate mortgage is something of a risk, as you may find yourself on a relatively more expensive mortgage should rates fall.

Thinking of fixing your mortgage rate?

Enjoy fixed monthly mortgage costs for a set period, whatever happens in the financial markets

Switch to a tracker mortgage

tracker mortgage is linked to the Bank of England’s interest rate with an added mark-up.

For example, your mortgage could be the interest rate +2%, so currently you would be paying a rate of 2.1% on your mortgage repayments.

Many people choose tracker rates as it offers some long-term security (many tracker rates are “lifetime”) and will likely follow the wider economy, so when times are good you should pay more and less when times are a little tighter.

Considering a tracker mortgage?

Find a mortgage that will follow the base rate of interest set by the Bank of England

Switch to a variable rate mortgage

variable rate mortgage will follow a lender's SVR. Often you will be able to enjoy an introductory offer or a discount from the SVR, which could bring your rate as low as around 1%.

Traditionally, discounted variable rates were the cheapest rates available on the market. However, this isn't necessarily the case any more, so make sure to compare all your options.

Are you happy to see where variable rates go?

Find a discounted variable rate mortgage that could stay at a level you're comfortable with.

What could the base rate cut do to savings interest rates?

A base rate cut is bad news for savers, who could see returns for cash deposits drop even lower than they are.

Savers have had something of a difficult time finding decent interest rates in recent years with rates getting lower and lower, with average savings rates hovering around the 0.5 to 1% mark at best.

Average interest rates (AER) paid on cash deposits 2017

How can you get better rates for your savings?

Looking for better returns from your savings will remain a challenge during these difficult times.

High interest current accounts

The main hope for savers at the moment are high interest current accounts that offer rates as high as 5% (with certain limitations).

Remember that as of April 2015 the first £1,000 of interest earned annually from current accounts is out of tax for basic-rate taxpayer (£500 for higher rate taxpayers).

It's also worth noting there are switching incentives of around £100 on offer for switching to a new bank account.

Where you can't find a bank account that gives you a decent AER, you could at least get a nice cash welcome bonus.

Could your current account pay you more?

Find a current account that will pay a higher rate of interest on your deposits

Get an offset mortgage

An offset mortgage effectively enables you to save at your mortgage rate. Where your mortgage rate is higher than the best savings rate you can find it is worth considering.

These mortgages work by combining a savings account with your mortgage. This means that the money you have in your savings account can be counted as a temporary overpayment towards your mortgage.

For example, if you had a £100,000 mortgage and £20,000 of savings, you could deposit your savings with your lender and you’ll only be paying interest on £80,000 (but you’ll still owe £100,000).

If your mortgage APR was 3%, you’d be saving around £600 worth of interest charges a year from your mortgage.

If you could only get a 1% rate paid on £20,000 (£200 per annum) in a savings account, then you’d be roughly £400 better off by offsetting your mortgage.

Want to save at your mortgage rate?

Compare mortgages that allow you to offset your savings against your mortgage debt

Alternatives to cash - bonds, stocks and shares

If you want better returns from savings you could consider investing in alternatives to cash.

Unfortunately as a rule, the better the returns from an investment, the riskier it tends to be and there is always the risk you may even end up losing money by investing in alternatives to cash savings.

You will also not enjoy the same £85,000 deposit guarantees from the Financial Services Compensation Scheme (FSCS) as would for cash deposits.

Government or premium bonds are a safe bet to at least keep your savings safe, but returns are not necessarily guaranteed as prizes are 'won' on a random lottery basis.

In all cases before investing your savings in alternatives to cash it's wise to seek independent financial advice.

Lifetime ISA

The Lifetime ISA launched in April 2017 also offers a government bonus of 25%. You can deposit up £4,000 a year. But you have to wait until you are 60 to enjoy the bonus, or you can access your savings and bonus when you buy your first home.

Read more …