There’s often lots of chatter in the media about the consequences of a rise in the base rate. But what does the base rate actually mean for you and your personal finances?
What is the base rate?
The base rate is the interest rate the Bank of England will charge to lend money to commercial banks – essentially the ‘price’ that banks can buy money for. It is set by the Monetary Policy Committee (MPC), who meet eight times a year, roughly every six weeks.
The base rate is a tool that can be used to help the economy: it can be reduced to stimulate the economy, or it can be raised to lower demand and keep inflation in check.
Since the financial crisis of 2008, the base rate has been at historically low levels; however, in recent years we have seen a couple of rate rises, and it now stands at 0.75%.
How does it impact me?
You are probably more curious about how a rise in the base rate will actually affect you, rather than the mechanics behind how it works. As a general rule, if the base rate goes up, borrowing becomes more expensive while savings can give you better returns, and vice versa if it goes down.
However, say tomorrow the MPC decided to implement a 0.25% rise. If this were to happen – and there are no indications at the moment that it will – what would that mean if you hold a mortgage, savings account, personal loan or credit card?
How quickly you feel the effect of an increase in the base rate depends on what type of mortgage product you hold. If there is an increase in the base rate, some products will be affected immediately while others could change over time.
If you hold a tracker mortgage, then you will know immediately about any increase in the base rate. As the name suggests, tracker mortgages ‘track’ the base rate. Your rate is likely to be something like 1.5% plus the base rate. So, using this example, when the base rate is 0.75%, your combined rate is 2.25%. However, if the base rate were to rise 0.25% to 1%, then your tracker mortgage rate would increase to 2.5%, making your monthly mortgage repayments more expensive.
If you hold a standard variable rate mortgage (SVR) or a fixed-rate mortgage, then you won’t know about a rate rise immediately.
With an SVR mortgage, the lender can choose whether to pass down any increase in the base rate, but will need to inform you ahead of time of any rate changes.
For a fixed-rate mortgage, your rate is fixed until the end of the term. The only thing to be aware of with this type of mortgage is that if there has been a rate rise, by the end of your agreed period you may find that mortgage products are more expensive as a result.
Similar to mortgages, with some savings products you will instantly feel the benefit of a base rate rise, while with others the impact may be further down the line.
If you hold a tracker savings account, it works in much the same way as a tracker mortgage. So if there is an increase in the base rate, you will immediately see an increase in the rate of interest you are earning on your savings.
With other savings products, it is expected that any increases in the base rate are passed down by the bank, meaning you can earn more interest on your deposits. However, this is not guaranteed, and in recent years we have actually seen providers reducing their savings interest rates despite an increase in the base rate. So always check with the provider what is on offer and whether this will change over time.
Personal loans and credit cards
If you have a personal loan, then your rate will have been agreed when you took your loan out, so you won’t be affected by any rate rise during the lifetime of the loan.
However, if you are looking to take a loan out, the cost of borrowing typically follows that of the base rate, so you may find that personal loan rates are higher if the base rate has made a jump.
Similarly, with credit cards you are not likely to see any immediate change in the cost of borrowing. However, providers can choose to pass down any changes in the base rate and therefore increase their standard rates. But the key thing here is that they need to give you notice and inform you of any changes ahead of time.
What can I do?
There are a couple of things you can do to protect yourself against any rises in the base rate.
If you are considering a tracker mortgage, then you can calculate whether or not you can afford an increase in your monthly payments, based on the predicted increase in the base rate. It’s best to do this before you apply for the mortgage. If it looks like this could stretch your finances a bit too much, and you need to budget ahead, maybe a fixed-rate or another type of mortgage would appeal.
If you are concerned about the cost of borrowing on credit cards and potential increases in average credit card APRs, then consider getting a 0% purchases or 0% balance transfer card. These offer an interest-free introductory period, protecting you against incurring any interest charges. Just be aware that with any credit card you need to be able to make your minimum payments in order to avoid hurting your credit score.
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