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What Does the Interest Rate Rise Mean?

22nd June 2022
Redrow - Inspiration - What Does the Interest Rate Rise Mean

UK interest rates have increased for a fifth month, the Bank of England has announced, but what does it mean for homeowners and those considering buying a new home?

What is the interest rate?

The Bank of England base rate sets the level of interest all other banks charge borrowers.

Prior to December the rate was at an all-time low of 0.1% (having been reduced at the start of the pandemic in March 2020). The purpose of the interest rate – what you pay for borrowing money, and what banks pay you for saving money with them – is to help regulate inflation.

Who sets interest rates?

The government sets the Bank of England a target designed to keep inflation low and stable and the bank’s Monetary Policy Committee (MPC) decides on the interest rate, taking into account inflation, economic growth and employment levels. At the MPC meeting on June 15, members voted to increase the interest rate. 

What is the interest rate going up to?

The new interest rate is 1.25%, up 0.25% from 1% in the fifth consecutive rise. While the latest increase pushes the rate to its highest level in 13 years, it’s still historically  very low. The UK interest rate averaged 7.2 % between 1971 and 2022, reaching an all-time high of 17% in November 1979 and a record low of 0.1% in March 2020. Even if further rate rises happen, the rate is still comparably much lower than it has been previously.

Why has inflation risen?

Rising gas and electricity costs, plus record fuel prices, are the main factors pushing up prices across the economy. Staff shortages are also impacted in some areas together with bottle necks in global supply chains, which are pushing up the prices of tradable goods.

All of this, alongside shortages of some food supplies, has seen supermarket prices go up too.

What will the rate increase mean for my mortgage?

With each base rate rise, other banks “protect forward”. This means that as borrowing gets more expensive for them, they pass it on to the consumer.

Anyone with a tracker mortgage will see it increase straight away as these are linked directly to interest rates.

Longer fixed terms have always been a better option to guard against sudden payment increases, with two-year  plans usually being the optimum period – although five and 10-year fixed rate periods have become increasingly common and give you more breathing space.

The drawback is that they sometimes come with bigger penalty clauses and Early Repayment Charges (between 1-5%) should you decide to move house or change providers before the term is up – and lenders are now charging higher upfront fees to allow them to offer lower rates and recoup their losses elsewhere.

While any increase is unlikely to be welcomed by mortgage holders, they can take reassurance from the fact that mortgage deals at the moment are still at a historically low level. 

What should I do?

As interest rates currently remain relatively low, it could be an opportunity to assess if it’s worth choosing to remortgage now and move on to a longer-term fixed mortgage rate.

The reassuring news is that current forecasts indicate that any further changes are likely to be small, but steady. So, while this latest rise might not set alarm bells ringing, several consecutive raises could have a more significant impact. With this in mind, it’s a good idea to have a financial plan in place to deal with any further interest rate changes.

Since there isn’t generally a huge difference between rates being offered for two and five-year deals, you might want to think about opting for a five-year deal to insulate yourself against future rate hikes – particularly since you may need to pay fees to remortgage once a two-year deal expires.

Crucially, if you are looking to buy or remortgage between now and late summer it’s worth starting to consider your options now. A lot of lenders’ offers are valid for six months so it’s not too early to start looking, even if you are planning to get a mortgage as far away as six months’ time.

For further information and bespoke advice for your circumstances, speak to an Independent Mortgage Advisor.

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