What Effect Bank Interest Rates Have On Me And My Mortgage

If you are like most people paying off debt, especially mortgages, you should be familiar with interest rates. Of course, we all know interest rates dictate the interest for your loan repayments. Nevertheless, have you asked where these interest rates come from?

Sure, they come from commercial banks. However, it is surprising how commercial banks arrive at such rates, to the point that different banks may offer different bank rates on loans. Could there be a mother organisation or individual behind these interest rate determinations?

Yes, there is an organisation. A bank – usually referred to as the central bank. Central banks around the world lend monies to commercial banks at an introductory rate also known as a base rate. Based on the base rate, commercial banks can also set their interest rates when they lend to other banks, businesses and individuals.

This invariably means that, when the central bank’s base rates are low, you are assured relatively cheaper (low interest) loans. 

The Bank of England Base Rate:

Currently, the base rate set by the Bank of England is 0.1%. This is a significantly low base rate. According to the Bank of England, the low base rate serves as a way to ease the financial burden on businesses and households during the pandemic. 

The Journey So Far:

Its base rate has not been this low all this while. From as high as 5% before 2008, it was dropped to 0.5% after the 2008-2009 financial crisis. It remained at 0.5% for 7 years before dropping to 0.25% between August 2016 and November 2017. Between November 2017 and August 2018, the base rate had moved slightly up to 0.5%. Moreover, it moved slightly up again to 0.75% between 2 August 2018 to 19 March 2020, where it dropped to 0.25% until it was dropped again to the current rate of 0.1%.

Who Is Responsible For These Base Rate Changes:

The Monetary Policy Committee (MPC) usually decides the rates based on voting, which they do either times a year (though they may decide to change it any other times the committee deems necessary).

Why The Changes?

The MPC simply changes the base rate to control inflation in the country. Thus, if lowering the base rate to increase borrowing will benefit the economy, they are likely to lower it. Likewise, if spending is high in the country (which threatens inflation), they raise the rate.

Enough of the Info, What Does It Means For Me?

A lot. If you are a borrower, you get the advantage of securing loans at a very affordable interest rate. However, if you are a saver, it means you will earn lower interest on your savings account.

Will an interest rate rise affect my mortgage?

Sure, it does. At the most reduced rate of 0.1% now, banks will be willing to offer mortgages at reduced interest rates too. Which is good news for a new borrower. If you are already paying a variable-rate mortgage, you are likely to enjoy some interest reductions in your repayments accordingly. However, if you are currently on a fixed-rate mortgage, chances are you may not feel the effects until your term-end. When it does, you are moved onto your lenders Standard Variable Rate (SVR).

Certain Mortgages React To Base Rate Changes:

Tracker mortgages: just like a stock market index, tracks changes in the base rate and applies the updated rate plus a set margin. Thus, if the base rate moves from 0.1% to 0.2%, your new repayments will reflect the new rates.

SVR mortgages: Standard Variable Rate (SVR) is your lender’s default fallback rate that you get moved onto once your fixed-rate mortgage term ends. Should base rates increase while you’re on the SVR, your bank is likely to increase your costs too, though usually not the full amount. Therefore, it is advisable that before a fixed rate borrower’s term ends they remortgage to avoid further costs from the lender’s SVR.

Discount Mortgages: Some lenders may offer a discount on their SVR. Such discounted mortgages last for a duration of two and five years. However, just like in the case of SVR mortgages, future price changes may apply and can affect the overall discount you hitherto enjoyed.

Fixed-rate mortgages: These mortgages are fixed. Thus, they are not affected directly by future changes in rate. It is therefore a safe option for you when the base rate at the time of the mortgage is low and you would prefer to stick with that for some time. It is important to note however that once your fixed-rate term ends, you will be switched to your lender’s SVR. Therefore, when the base rates are low, you may want to switch to a cheaper deal before your term ends.  

Could The Base Interest Rate Reduce Further (Negative Base Rate):

Despite the Bank of England’s plans to reduce base rates to zero, it will have very critical implications. 

While loans will be so affordable for borrowers, savers may have to pay banks to save their monies. Whether the Bank of England implements that in the future is something we all live to witness.

In the end, a central bank’s base rates have varying effects on the economy, from mortgages to savings to inflation. While reducing it may help you save costs on your mortgage, it may add up costs on your savings account. It is therefore important to stay updated on how much the country’s base rate is to help you prepare for your finances.

Links that may help you

Stay on top of base rates rises and learn how to beat inflation with investments

Keep an eye on the best, fixed-term mortgages at Money Super Market