The interest rate impact on mortgages and savings

POSTED: 27th March 2015
IN: Personal Guides

Bank of England Governor Mark Carney is keen to quash rumours of a potential interest rate reduction, despite a rapidly falling inflation rate.

undefinedWith inflation falling, speculators have gone from predicting an interest rate rise on the horizon, to wondering if the Bank of England might instead decide to drop rates to 0.25 per cent. However, Governor Mark Carney has deflected these suggestions, stating that the deflationary effect of fallen oil prices will be short-lived and confirming the Bank still expects rates to rise within the next year.

Amidst the speculation and predictions that always accompany the interest rate debate, ordinary consumers will be wondering what it all means for their personal finances.


Mortgage borrowers

The consensus that interest rates may rise within the next twelve months means mortgage borrowers need to plan carefully for the future.

An increase in rates would result in higher monthly repayments for people on tracker mortgages or their lender's standard variable rate. It could also lead to lower demand from buyers, which would affect prices in the housing market.

In July 2014, the potential impact of medium-term interest rate increases on mortgage borrowers was underlined in a report from the Resolution Foundation think-tank.

The report noted that the number of households spending more than a third of post-tax income on servicing their debt could rise from the current one million to about 2.3 million by 2018. This is based on the possibility of interest rates rising to almost three per cent over the next four years.

According to the Resolution Foundation, a policy overhaul is required to help British households manage the transition to "a world of more normal interest rates".

Gavin Kelly, chief executive of the think-tank, said: "Alongside tackling the deficit, carefully managing the return to more normal interest rates is one of the great challenges of the next parliament."

In the short term, one of the most significant effects of the MPC's reluctance to raise rates too soon is stiffer competition between mortgage lenders. With interest likely to remain at a record low for at least a few months, the market is likely to see an influx of buyers looking to make the most of the cheap borrowing environment.

City AM reported that the low likelihood of an imminent rate hike prompted a price war between lenders, with several banks and building societies slashing their rates.

However, Joanna Elson from the Money Advice Trust warned against consumers falling into a false sense of security about low rates and cheap borrowing.

"We all need to do more to prepare mortgage payers for future rate rises, which our research with the Building Societies Association shows could tip more than one in four into difficulty," she said.



Savers, unlike mortgage borrowers, will view a potential interest rate hike - and the possibility of gaining higher returns on their savings - as a welcome prospect.

Carney’s comments will therefore bring reassurance, particularly given the fact that interest has been at an unprecedented low for over six years.

According to recent research by SavingsChampion, commissioned by the Daily Telegraph, savers have actually received lower returns over the past two years, even though interest rates have not changed.

Sue Hannums, a co-founder of the savings advice provider, said this can be attributed to government policies that have incentivised banks to lend to mortgage borrowers and small businesses, making savers less of a priority.

"Banks have cut rates because they have had less need for savings deposits," she said.

"Even if [the] Bank rate starts to rise, it is likely to be years before the income available from savings accounts returns to the levels we saw in 2012."

It hasn't been all bad news on savings front, however. On July 1st 2014, the government introduced the new ISA, increasing the tax-free savings limit to £15,000, set to rise to £15,240 from 6 April 2015, and giving consumers the flexibility to split their savings between cash accounts and stocks and shares products as they choose.

For those approaching retirement, the January launch of new 'pensioner bonds', offering interest rates of up to four per cent, also provided another viable investment option.

For savers looking for the best possible returns on their cash, it is worth shopping around and comparing the various offers available.

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