It had been a warm June but unsettled weather was ahead when the Bank of England last raised interest rates on 5 July 2007. The rise from 5% to 5.25% was not remarkable at the time. The rate had gone up several times over the four previous years. Much more newsworthy was the recent resignation of Tony Blair after ten years as Prime Minister and the ban on smoking in pubs and restaurants which began four days earlier.
Since then rates have pretty much gone one way, diving down to 0.5% in March 2009 and then to the record low of 0.25% in August last year. Half a generation of homebuyers have only known rates go down, not up.
So this morning’s quarter point rise in Bank Rate back to 0.5% is a significant and major change. Not least because the expectation is that further increases will follow.
What’s it for?
The purpose of raising and lowering rates is to control the economy. With inflation now 3% and rising and with economic growth set to be at a reasonably normal rate this year the Bank had little choice but to put up rates. The idea is that more expensive borrowing and more attractive savings rates will encourage people to spend less and save more.
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Older people have billions of pounds in cash accounts and one of the most common complaints I get is ‘my money earns nothing’. It is true of course that interest rates paid on savings are pretty negligible. The average rate is just 0.14% on instant access, 0.3% on cash ISAs and only 1.26% a year on money tied up for two years.
The problem is that the big banks do not need our money. They can borrow it very cheaply from the Bank of England anyway. So the rise in Bank Rate is unlikely to be reflected quickly in the typical rates paid to savers.
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However, over the last few months best buy rates have been rising as new banks have taken up the slack, and today’s change can only encourage that trend. For example, you can get nearly ten times the average rate on instant access by moving to one of the best rates paying 1.3%. Similarly, if you can tie your money up for two years, it can earn 2% or more. Even best buy one year deposits are paying close on 2%.
The key is to move your money at least once a year to chase the best rates.
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Some commentators expect to see new deals with higher rates come onto the market in the next few weeks. But you may have to be quick to snap them up. Remember too that ISAs pay slightly lower rates than normal savings accounts and unless you pay higher rate tax or have tens of thousands of pounds in savings accounts you will probably not pay any tax on your savings anyway.
The consumer group Which? estimates that more than four out of ten who have a mortgage have taken it out within the last ten years. So this is their first taste of rates rising.
The most obvious losers will be those with a mortgage rate tied to the Bank Rate. Their interest rates and repayments will follow Bank Rate automatically and add £10 a month to repayments on a typical loan. Of course for those with bigger loans the rise will be a lot more – say £20 on £150,000 loan. Rates for the rest who do not have a fixed rate mortgage will rise when their lender decides to follow the Bank and put them up.
The pain will be deferred for those with fixed rate loans – but when they run out and have to be remortgaged in one or two years they should brace themselves for higher repayments. In some case they may be refused a loan on the grounds they can no longer afford one so big. They should start preparing now by repaying some of the loan if they can.
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The long-term problem is that if rates continue to rise then repayments will continue to rise too. At the moment mortgage lenders check that new borrowers could afford a loan even if rates rose by three percentage points. If today’s rise puts us back on track to a more normal Bank Rate – say around 6% – then many current borrowers may end up in difficulties.
Older people who have borrowed against their property with an equity release lifetime mortgage will generally see no change as almost all of those are fixed for life.
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Although best buy personal loans can now be as cheap as they have ever been, the average rate has fallen by less than one percentage point - from 9.1% to 8.2% – even as bank rate has plunged over the last ten years by 5 percentage points from 5.25% to 5%. Most personal loans are at a rate fixed for the term of the loan so they will not change. But the cheapest deals are already rising and that trend will continue for new borrowers if Bank Rate carries on moving up.
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The average interest charged on credit card balances is still 18% - higher than it was ten years when it was just 15%. The banks may hope we do not remember that and use the rate rise as an excuse to raise rates further. If you have a credit card, paying it off is one of the best investments you can make with any spare cash you have.
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Overdrafts too are now more expensive than they were in 2007. The Financial Conduct Authority is already looking at the high cost of going overdrawn so banks will probably not use the Bank Rate rise as an excuse to raise the cost of an overdraft. But they are already so expensive that paying down an overdraft is a great way to save money every month.
Even with Bank Rate at 0.5%, we are a long way from normal. But this may be the first tentative step towards that goal. If so it will mean better returns on savings and more expensive borrowing for mortgages and consumer loans. Since 1950 Bank Rate has averaged around 6.5%. That makes today’s rise to 0.5% seem modest indeed.
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