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Interest Rates - what does the base rate mean for you?

  1. 14 August 2018
  2. By Andi Michael

With the recent decision by the Bank of England to raise interest rates to 0.75%, we ask what this means for the property market.



After a long period of hype and speculation, the Bank of England decided to raise interest rates this month – from 0.5% to 0.75%.

Despite recent rises in inflation, strong employment levels, increased consumer spending (helped by the recent heatwave and the World Cup), the potential for wages to rise and expectations for a strengthening economy all helped the Bank's Monetary Policy Committee (MPC) –  the nine-strong group which decides the country's base rate – to come to their decision.

The base rate acts as a reference point for banks and building societies on how much they charge borrowers or pay savers.

But what does a rise in interest rates – albeit a modest one – mean for you?

An increase in mortgage costs?

Typically, interest rate rises are seen as a boon to savers but less good news for mortgage borrowers. Those on variable rate or tracker rate mortgages – which is more than 3.5 million of the approximately 9.1 million mortgage holders in the UK – are most directly impacted by a rise in interest rates, with their monthly payments increasing as a result.

The average standard variable rate mortgage is currently 4.72%, so – taking a home with a £150,000 variable mortgage as an example – an increase to 0.75% is likely to increase the annual cost of a mortgage by £224 (or just over £18 a month).

Thanks to the modest rise, most mortgage-holders will not be too badly affected, but debt charities have pointed to struggling families as one group who could find the increased costs especially painful and challenging.

In the main, though, those on variable rates tend to be older and closer to paying off their mortgage. The average outstanding balance for someone on a variable rate mortgage is £112,000, which means that somebody with 20 years left on their mortgage will see monthly bills go up by about £14 a month – which many would argue is hardly intolerable.

However, those with bigger outstanding balances and more squeezed finances could find things more difficult.

What about first-time buyers?

Most first-time buyers opt for a fixed-rate deal when purchasing their first home. They are advised to do so for the extra stability and security – with monthly payments fixed for a set period – this type of mortgage provides. Of course, if you're on a fixed-rate mortgage, you are shielded from any rise in interest rates.
 
Nearly all new mortgage loans – 96% - are fixed-rate deals, often for two or five years. As things stand, around 4.7 million households are on fixed-rate deals, which amounts to half of all mortgages in the UK.
 
While borrowers on a fixed-rate deal will see no immediate increase in their payments, this could change at the end of their term, where they could face higher monthly costs. At the same time, though, people could end up on a cheaper deal as lenders providing fixed-rates tend to offer competitive rates to entice borrowers.
 
For those buying their first home now, the interest rate rise could lead to a more expensive fixed-rate, but there are no guarantees over this. Of course, if a first-time buyer opts for a tracker or variable rate mortgage – which some do – they will face higher monthly costs thanks to the interest rate rise. On the flipside, if interest rates were to fall again, borrowers on these terms would benefit.

Should those considering remortgaging still act now?

For those looking to remortgage to cut costs, it may feel like the boat has been missed given interest rates have already increased. This means the opportunity to lock in deals with favourable conditions has passed, but with interest rates set to rise again in the coming years – albeit gradually – homeowners eager to remortgage may still be best off acting now before rates increase further. Further rises are expected in 2019 and 2020.
 
Generally, remortgage activity soars off the back of a rate rise, or if fears are high that another one is imminent, as mortgage holders look to fix deals to avoid facing more expensive monthly payments.
 
For a long time, interest rates were kept at record lows – first of 0.5%, then 0.25% - as a reaction to the global financial crisis and, later on, Brexit. Rates didn't increase at all for a decade until the Bank of England decided to act last year, while the increase to 0.75% means interest rates are now at their highest level since March 2009.
 
Financial markets anticipate two further rises of 0.25% - dragging the base rate up to 1.25% - by 2020, but a return to interest rates of 5% or more, which was the case before the financial crisis hit, is highly unlikely. The Bank of England, in its recent inflation report, said the natural interest rate for the UK economy is between 2% and 3%.

A more limited impact than before

Most borrowers with large mortgages are on fixed rates, but in 2001 that wasn't the case. Now, 35% of people have a variable mortgage – which tracks the base rate and moves up and down in price accordingly – in comparison to 70% at the start of this Millennium. Even those who are affected are not facing massive hikes as a result of the 0.25% increase.
 
If rates were to rise more quickly – say, by 1.5% - this would have a much bigger impact on household finances, but the Bank has insisted rate rises will be gradual and limited.
 
One consequence of the interest rate rise is likely to be an increase in popularity of 10-year fixes with interest rates that are only slightly above those being paid by households on two or five-year deals. Coventry Building Society, for example, is allowing customers to lock in for 10 years at only 2.39%, while HSBC is offering 10-year fixes at only 2.49%. 
 
What's more, the impact on house prices – and those looking to sell their homes for what they believe it's worth – is set to be modest. The Halifax, in its latest survey of house prices, said it did not expect the rise to have a ‘significant effect on either mortgage affordability or transaction volumes’.
 
The property market in London and the South East – which has been struggling of late – could be most affected by the rate rise, though, as home ownership becomes more expensive. Prices in London, which are already on the decline, are expected to continue to fall in the next few years thanks to Brexit and the prospect of further interest rate rises. Outside of the capital, though, there is expected to be little impact on house prices.
 
 

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