The Bank of England decided to hold interest rates at their historic low of 0.25 per cent on 03 August 2017. Inflation receded slightly last month, from 2.9 per cent to 2.6 per cent, relieving the pressure on the bank to increase rates for now.
With wage growth relatively flat and consumer indebtedness rising, a rate increase may be hard for some to manage.
However, economists still predict that the bank will choose to add a quarter point to interest rates, bringing them back to 0.5 per cent, in the next few months.
What this means for you will depend on whether you are mostly a saver or mostly a borrower. In basic terms, savers are rewarded by higher interest rates, and borrowers are penalised.
In reality, most people have some debt and some savings. The balance tends to tip more towards savings as you get older and pay off your debts.
Mostly a borrower?
People with mortgages, credit cards, personal loans and other types of finance deal have benefitted from relatively low borrowing rates in recent years. This in turn has fuelled an increase in credit. Consumer borrowing on credit cards and loans per person has risen by 10 per cent in the year to June.
The problem with this is that those who are indebted may struggle to afford higher repayments if rates do rise.
A 0.25 per cent rate rise on a mortgage of £100,000 on a variable interest rate of 2 per cent is an extra £12 a month. On a personal loan of £20,000, repaid over 5 years, a quarter point rate rise on a 3 per cent interest rate would result in a rise in monthly repayments from £359 to £362.
On their own, these increases seem manageable, but if you have a few credit cards, as well as a loan, overdraft and mortgage, the increases can soon feel painful.
How to prepare:
- Make sure your debts are on the lowest possible rate.
- Fix your interest rate if you think you would be unable to cope easily with rate rises. Fixed mortgage rates tend to be higher because there is a slight premium for the extra certainty (the lender is absorbing the risk of future rate rises beyond what the money markets are expecting). But if you don’t think you’d manage two or three quarter point rate rises on a variable rate, a fix could be worthwhile.
- Overpay while you can. If you are comfortably managing your current debt levels, you could try reducing the debt more quickly by paying off more each month. Try rounding up your repayments to the nearest £100. If you get your debt as low as possible, when the rate rises come, you will have a smaller balance on which to repay the extra interest.
Mostly a saver?
Most savings rates are currently lower than inflation – the pace at which prices are rising, which is 2.6 per cent. This means savings that are earning less than this are losing value in ‘real terms’ (taking account of price inflation) over time.
Annuity rates – which are paid on annuities that retired people often buy with their pension pots, are also very low.
So pensioners, with their savings and pensions, have been losing out the most from low interest rates and stand to gain the most from a rise.
How to prepare:
- Check what interest rates your savings are earning. You could switch to a variable interest rate in anticipation of a rise, but bear in mind that interest rate increases on accounts are at the bank’s discretion – they don’t automatically increase savings in line with base rate rises. Some banks and building societies offer tracker savings accounts, guaranteed to pay a minimum of a certain per cent above the Bank of England base rate. Using one of these means you will automatically benefit from a rate rise.
- There is a personal savings allowance of £1,000 of interest that can be earned interest-free each year. If you have a large savings pot, make sure an interest rate rise on your savings wouldn’t take you over this threshold. If it does, consider moving some savings into a cash ISA instead. There’s a £20,000 limit on ISA balances, on which you would not pay tax on interest or on capital gains.
- Review your investments. Changes to interest rates also have a bearing on the performance of other asset classes, such as equities, gilts and bonds. Rising interest rates can make the yield from bond funds less attractive, for instance. Stocks that tend to benefit when interest rates are higher are banks and insurers, but it can be difficult to second guess markets and investors may respond unpredictably to the first interest rate rise in more than 10 years.