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Interest rates – what to expect and how to prepare

Rate rises have been pushed back further and further, and now are likely to be cut after the British exit from the EU (Brexit)

Interest rates going down would be bad news for those with savings – who will get worse returns on their deposits – but good news for those with mortgages – who will see their monthly repayments become cheaper.

The current situation:

  • The base rate is currently at an all time low of 0.5% and mortgage rates have never been cheaper
  • Prior to Brexit the base rate was likely to gradually increase to 2.25% from late 2016, now no change or cuts are likely
  • This means mortgage costs may go down
  • Fixed rates have already become lower than variable rates

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What is the base rate?

The base rate of interest is set by the Monetary Policy Committee (MPC) of the Bank of England (BoE), it is the price banks and other commercial lenders ‘buy’ their money at, and is the interest rate that all others follow.

That means that if the base rate goes up, the interest rates on commercial mortgages, loans, credit cards and savings accounts will too.

The base rate of interest has been at the historically low rate of 0.5% since 2009 to help stimulate the economy following the financial crash of 2008.

Before the Brexit vote, growing confidence in the financial sector combined with the all-time low base rate of interest, has lead to some of the cheapest mortgage rates ever now being available.

But now a rate cut is likely.

In either case, low rates will not last forever. Not only is a low base rate risky in the long term, but there is also a lot of pressure from investors and savers for higher interest rates.

Will interest rates be cut?

Predictions on interest rates have been consistently wrong for the past few years as rate rises were continually deferred.

But Brexit has changed the landscape. At the time of writing the only certainty is uncertainty, but a cut in rates seems likely in the near future.

Before Brexit

BoE Governor Mark Carney constantly pushed back the date for rate rises, mindful of “slack” in the UK economy and reports suggesting many households would struggle if interest rates rose to quickly, or too soon.

Though, the final BoE quarterly report for 2015 stated: “Households appear a little better placed to cope with a rise in interest rates than a year ago and survey responses do not imply that a rise in rates would have an unusually large impact on spending.”

Prior to the result on 23 June 2016, the plan from the BoE was to eventually and gradually raise rates:

“It would not seem unreasonable to me to expect that once normalisation begins, interest rate increase would proceed slowly and to a level in the medium term that is perhaps about half as high as historical averages.”

As rates have averaged around 4.5% over the course of the BoE’s 300 year history, this meant a gradual rise from 0.5% to 2.25%. However, these plans have likely been put on hold for the time being after the result of the Brexit referendum.


After Brexit

In the last quarterly report before the referendum the BoE stated they would “face a trade-off between stabilising inflation on the one hand and output and employment on the other” in the event of a Brexit vote.

By this they mean:

  • If there is inflation (prices going up), the bank will be under pressure to raise interest rates
  • If there is falling output and employment the BoE may decide to cut rates to stimulate growth in the UK economy

The BoE have not yet formally stated whether they will change their plan of keeping rates at 0.5% and raising them at some point within the next year, but Governor Mark Carney has dropped some strong hints rates will be cut soon.

He has as yet not specified, when or by how much rates will be cut.

How will mortgages be affected?

Looking back at the past you can see how mortgage rates are highly sensitive to changes in the base rate:

base rate of interest vs mortgages

If we assume that mortgage rates will decrease roughly in line with the base rate, we could roughly guess how much the cost of mortgages would change.

But many other wider market forces affect mortgage rates, so don’t bet on the base rate being cut alone.

Is it worth fixing a mortgage rate?

fixed mortgage rate will set your mortgage rate for a period of time (typically two, five or ten years), as opposed to a variable rate which will vary at your lender’s discretion.

Knowing when to fix a mortgage rate is tough – whilst fixing protects you against rate rises, you risk being caught out, as rates may become cheaper and you’ll be stuck with a relatively high rate.

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Currently fixed mortgage rates have fallen to record lows, with a few deals below 1% appearing in June 2016. If the BoE cuts interest rates, these rates could become even cheaper.

However, deciding if rates will fall further requires a crystal ball. While the recent trend has been towards declining mortgage rates, market conditions could change overnight.

Should you make mortgage overpayments?

Low interest rates can lead to a common conundrum – are you better off overpaying on your mortgage or putting any spare money in savings?

The first thing to ask yourself is whether you have the option to overpay on your mortgage. Not all mortgages allow overpayments, and those that do may charge you for the privilege in the form of a one-off fee or a stepped fee.

Even then you should ask yourself whether you can afford it. Savings are great for earning interest, but are also a great fallback in the event of something going wrong around the house, or in the event your personal circumstances change.

However, that should be balanced against what you could save. Taking advantage of the current situation of relatively cheap repayments to pay back more of your debt means lower repayments in the future should rates eventually rise.

In addition the low base rate means savings might be put to better work to pay back more of your mortgage, rather than earning around 1-2% AER in a savings account. If you still want access to your savings you could consider an offset mortgage.

What can you do if you’re getting a mortgage or remortgaging in 2015/16?

If your outgoings are tight and you can’t afford the unpredictability of a rate rise, then fixing gives you reassurance you can afford your mortgage, no matter what happens.

If you are more financially secure it could be worth waiting it out to see how cheap rates can go.

In either case, make sure to compare mortgages on cost – consider all the fees (booking and exit) and always look at the APR as well as the initial rate.

You should always carefully consider what you can afford now and seeking independent financial advice before getting a new mortgage is always wise.

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