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What does the base rate cut mean for your finances?

The Bank of England cut the base rate of interest to 0.25% in August 2016, this new all-time low could spell cheaper mortgage payments but worse returns on savings

The base interest rate has been at all time lows of 0.5% ever since the midst of the financial crisis in 2009. It stayed at this record low for an unprecedented period of 7 years, and lead to gradually cheaper mortgage interest rates and poor rates for savings deposits.

Could you get a better rate for your savings?

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Many economists had been anticipating a rate rise since 2014, but Governor of the Bank of England, Mark Carney, has been a strong voice in delaying this rise, and now in the aftermath of the Brexit vote on 23 June 2016 the bank has decided to take rates even lower to 0.25%.

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

The base rate of interest is the ‘price’ of money 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 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.

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

In theory the base rate cut should be passed onto borrowers not long after it is implemented. The extent to which lenders will take this cut on board depends on other market influences and competition with other lenders.

base rate of interest vs mortgages

Governor Mark Carney issued a challenge to lenders when he announced the base rate cut, saying:

“the banks have no excuse not to pass this rate cut on. They should write to their customers and make that clear.”

But 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 lenders mortgage deals (other than tracker mortgages) will be based off of this rate.

What could this mean for repayments?

Repayments should fall for borrowers with mortgages that are on variable rate and tracker deals. Though the amount monthly repayments will fall by will depend on how your bank responds to the base rate cut and how much they will cut their SVR.

Those with tracker deals stand to see the most clear and direct fall in their monthly repayments with their rates falling by 0.25%.

Unfortunately those currently on a fixed rate deal will not see an immediate benefit of the rate cut, but as these low rates are not likely to go up anytime soon, it’s worth keeping an eye on the market and switching to lower rate when it’s possible to remortgage.

repayments and rate cut

What could you do with your mortgage?

With mortgage rates falling after the rate cut it could be tempting to remortgage to get a cheaper deal.

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 tracker mortgage

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

For example, if your mortgage could be the interest rate +2%, so currently you would be paying a rate of 2.25% on your mortgage repayments.

The main advantage of a tracker mortgage is that when the base rate falls your mortgage rate is guaranteed to fall.

But it’s worth noting tracker rates aren’t always the lowest rate on the market and you could potentially get a cheaper rate with a variable or fixed rate mortgage.

Also there is the possibility of feeling the direct hit of a rate rise. Which while this may seem like a distant prospect, but within the last ten years it has been over 5%.

Considering a tracker mortgage?

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Switch to a fixed mortgage rate

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

Switching to a fix rate mortgage is something of a risk, as you may find yourself on a relatively more expensive mortgage rate should rates continue to slide. However, current fixed rates are at historic lows so it might be worth considering fixing now.

Thinking of fixing your mortgage rate?

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

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Switch to a variable rate mortgage

A 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, the discounted variable rates were the cheapest rates available on the market. However, this isn’t necessarily the case any more, with some of the market leading fixed rate deals being cheaper than the lowest discounted variable rate.

Think rates might fall more?

Find a discounted variable rate mortgage that might have further to fall after the base rate cut

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

A base rate cut will likely be bad news for savers, who will see returns for cash deposits diminish.

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 – 1% mark at best.

savings vs base rate

But this 0.25% base rate cut could well drag rates down more. Before the cut was announced 13 of the best saving accounts disappeared from the best buy tables and Santander said they would ‘review’ their interest offerings.

How can you get better rates for your savings?

Looking for better returns from your savings will be a challenge after the base rate cut, but there are a few options.

High interest current accounts

The main hope for savers at the moment are high interest current accounts that offer rates as high as 3% (with certain limitations).

It’s also worth remembering that as of April 2016 the first £1,000 of interest earned annually from current accounts is out of tax (£500 for high rate tax payers).

Could your current account pay you more?

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

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Get an offset mortgage

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

These mortgages work by can 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 2% rate paid on £20,000 (£400 per annum) in a savings account, then you’d be roughly £200 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

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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 £75,000 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.

Help to Buy and Lifetime ISA

If you’re saving to buy your first home you could consider a Help to Buy ISA backed by the government. The scheme introduced in the 2015 Government Budget offers a 25% boost to savings.

But this boost is only available when you buy your first home, other terms and conditions apply too, you can read more about the Help to Buy ISA on the Help to Buy website.

The Lifetime ISA launching in April 2017 will also offer 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.

Help to Buy ISA

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Read more

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  • How can you manage your finances in Brexit Britain? – As Britain begins its preparations to leave the European Union the only certainty ahead is uncertainty. We explain what it might mean for you and how you can try to protect your finances
  • When should I fix a mortgage rate? – Fixed mortgage rates are getting increasingly competitive with rates at all time lows, but deciding on the right time to fix is difficult.