There’s always plenty of speculation about which way interest rates are likely to move next, but it’s not always easy to know exactly how rate movements will affect you.
If you’ve borrowed money then interest rates effectively determine how much you’ll have to repay. Put simply, the higher the Bank of England base rate is, the more it will cost you to take out a mortgage, credit card or personal loan. On the flipside, if you have savings, you’ll want interest rates to be as high, as this will boost your returns. Here, we explain everything you need to know about interest rates, so that you’re fully prepared for any changes.
What are interest rates?
Interest rates essentially tell you how much it will cost you to borrow money, and how much you’ll be rewarded with if you save. They are usually expressed as a percentage of the amount borrowed, or the amount saved. The most important interest rate in the UK is the Bank of England base rate, as this is the rate that influences the rates banks and building societies offer savers and borrowers.
How do interest rates affect my borrowing?
If you are taking out a personal loan, a mortgage, or a credit card, it’s extremely important to understand how interest rates work and have a plan in place for if they go up.
When the Bank of England raises the base rate, banks will usually charge higher interest too to keep up with the increased cost of borrowing.
This will certainly be the case if you’re on a mortgage with a “tracker rate” – this means that your mortgage rate will “track” or follow the base rate, with an extra percentage on top.
You might be able to get a mortgage, loan or other credit arrangement at a fixed rate, which means that the interest stays at a pre-agreed rate for a set period of time and you won’t have to worry about it shooting up if the base rate rises.
How do interest rates affect my savings?
When you put money into savings, you’re not just storing it away – that bank or building society is effectively borrowing the money from you, which means that they will pay you interest.
So if you place £1,000 in a savings account earning 2% annual interest, you will earn £20 interest in a year, leaving you with £1,020 (assuming you don’t add or withdraw any money during that time).
Just as with loans and mortgages, the interest rate on your savings may go up and down in line with the base rate, although there’s no legal requirement for providers to pass on any increase in full, or at all.
UK taxpayers are expected to pay income tax on savings interest, though you may get an allowance of money – called a personal savings allowance – that you can keep from this tax-free, depending on your tax bracket. Basic rate taxpayers have a personal savings allowance of £1000, higher rate taxpayers have an allowance of £500, and additional rate taxpayers do not get an allowance.
Research suggests that over half of Britons feel they would be worse off financially if interest rates were to rise. If you feel this applies to you and you don’t have a plan in place, check out our article What can you do to prepare for an interest rate rise? for more information.
If you want to speak to a mortgage adviser about your circumstances, we’ve partnered with an experienced mortgage advisor to offer Rest Less members high quality advice on standard, retirement interest-only and buy-to-let mortgages. You can book a free, no-obligation call back here.