THE Bank of England has raised interest rates to 0.5% – its second increase to the base rate in two months.
The decision comes just an hour after the new energy price cap was announced, and will add £700 a year to over 2million mortgage bills.
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Analysts had widely expected the central bank’s Monetary Policy Committee to increase the official interest rate from 0.25% to 0.5%.
The Bank of England (BoE)caught many people off guard in December 2021 when its members voted to lift rates to 0.25% from a historic low of 0.1%.
It was the first increase in more than three years but commentators were expecting action again today as the rate of inflation, which measures the cost of living, has soared.
The inflation rate is currently at a 30-year high of 5.4% thanks to high energy and food prices.
The BoE also said today that it expects inflation to rise further, close to 6% in February and March and then peaking at just over 7% in April.
The BoE has a target rate of 2% for inflation and iIncreasing the bank rate is a common lever for slowing down inflation.
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It’s widely expected that the BoE will make further rate hiked this year to try and keep it under control.
But when the Bank of England raises interest rates, the cost of borrowing increases.
This means that consumers and businesses have less money to spend, and in theory, as demand for goods and services fall, so should prices.
Banks are not obliged to pass on any interest rate rises to their customers, but a change can influence the cost of borrowing for loans, mortgages and credit cards
It can also affect how much interest you earn on your savings – but banks are often slower to pass on higher rates to savers.
So overall, you could find you are paying more for financial products.
Here are five ways your money could be hit by a rate hike.
If you have a loan, credit card or overdraft
Most unsecured borrowing such as car finance won’t usually be affected by an interest rate change.
This is because you agreed to pay a fixed rate of interest when you took out the loan.
But it is possible for the interest rate on your credit card or overdraft to rise.
Many customers of big providers such as Lloyds Bank, MBNA, Halifax and Barclaycard have their credit card rates directly linked to Bank of England base rate, so they will move automatically with any changes.
You’ll be given notice before this happens, subject to the terms and conditions of your account.
If you have a balance of £2,000 on your credit card, a 0.5% rate rise would increase your interest costs by £10 a year, and if you had £8,000, it would rise £40 a year.
And if you are looking to take out a personal loan AFTER an interest rate rise, you may find the cost of new borrowing has increased.
Your lender should let you know about any increase in your credit card or overdraft rate before it goes up.
Why does inflation matter?
INFLATION is a measure of the cost of living. It looks at how much the price of goods, such as food or televisions, and services, such as haircuts or train tickets, has changed over time.
Usually people measure inflation by comparing the cost of things today with how much they cost a year ago. The average increase in prices is known as the inflation rate.
The government sets an inflation target of 2%.
If inflation is too high or it moves around a lot, the Bank of England says it is hard for businesses to set the right prices and for people to plan their spending.
High inflation rates also means people are having to spend more, while savings are likely to be eroded as the cost of goods is more than the interest we’re earning.
Low inflation, on the other hand, means lower prices and a greater likelihood of interest rates on savings beating the inflation rate.
But if inflation is too low some people may put off spending because they expect prices to fall. And if everybody reduced their spending then companies could fail and people might lose their jobs.
See our UK inflation guide and our Is low inflation good? guide for more information.
If you have a mortgage
When, and if, your mortgage repayments are affected by an interest rate change will depend on what type of mortgage you have and when your current deal ends.
If you have a variable rate tracker mortgage, linked to the Bank of England base rate, then you are likely to see an immediate impact on your mortgage repayments if there is an interest rate rise.
Those on a standard variable rate mortgage will probably see an increase in their rate of repayment, but your lender decides how much that is, so it could be more or less than the Bank of England increase.
The latest data from UK Finance shows that 26% of residential mortgages are on variable rates.
This means the changes will affect around 2.2 million borrowers.
People with fixed rate mortgages are likely to be affected once they reach the end of their current deal. An interest rate rise could make remortgaging more expensive in the future.
For example, if someone currently paying 1% on a £200,000 mortgage over 25 years remortgaged at the end of the fixed period to a new deal costing 2%, it could push up their monthly costs by £94.
How do you find the best mortgage deals?
WE explain how to ensure you get the best deal on your mortgage or remortgage:
Websites such as MoneySuperMarket and Moneyfacts have mortgage sections so you can compare costs. All the banks and building societies will have their offers available on their sites too.
If you’re getting confused by all the deals on the market, it might be worth you speaking to a mortgage broker, which will help find the best mortgage for you.
A broker will typically cost between £300 and £400 but could help you save thousands over the course of your mortgage.
You’ll also have to decide if you want a fixed-deal where the interest you’re charged is the same for the length of the deal or a variable mortgage, where the amount you pay can change depending on the Bank of England Base Rate.
Remember, that you’ll have to pass the lender’s strict eligibility criteria too, which will include affordability checks, and looking at your credit file.
You may also need to provide documents such as utility bills, proof of benefits, your last three month’s payslips, passports and bank statement.
If you are unsure what type of mortgage you have, check your mortgage terms and conditions in your original mortgage offer document.
It is always worth shopping around to see if you can get a better deal on what you are currently paying.
If you pay tax
This is harder to quantify, but a side-effect of the rising Bank of England rates is that the government will pay more for its borrowing.
This could lead to tax increases, such as a rise in National Insurance.
National Insurance is already going up by 1.25 percentage points in April, adding hundreds to workers’ tax bills.
Another hike on top of this would be an unpopular move so is unlikely, but it is a tool the government could use.
In the past, the Treasury has also toyed with cutting pensions tax relief for high earners, increasing capital gains tax and introducing a digital sales tax for online retailers.
There is no suggestion that it will do any of these at the moment, but it may need to in the future if its borrowing costs continue to go up.
If you have savings
It’s not all bad news when interest rates go up.
If you’re a saver you could see an increase in the interest you are getting on variable rate saving accounts and cash Isas.
Although in the past, banks have typically been slow to pass on any increases.
It’s also worth pointing out that a marginal rate hike doesn’t do an awful lot to boost your savings – if you had £1,000 earning interest of 0.25% that’s just £2.50 a year.
If that rate went up to 0.5%, you’d earn £5 interest a year.
The rise could prompt banks to offer better rates on a range of savings products in future, so it’s worth keeping an eye on them in the coming months in case you find better.
Savings rates have been at historic lows recently, and with inflation rising this can eat away at your cash. Shopping around for the best rate can help ease this pain.
The Bank of England is expected to increase the base rate further this year. Experts expect four hikes in total which would take the rate 1.25%, although there’s no guarantee of that.
Fixed deals where you lock up your cash for a certain period often offer the best rates. If you’ve already fixed then your rate won’t increase with today’s rate rise, or future ones.
Further hikes could see rates on new fixes improve, but savers risk being locked into less competitive rates if they get a fixed rate now.
Laura Suter, Personal Finance expert at AJ Bell said: “If you have £10,000 saved and put it in the top two-year fix now you’d have made £327 interest at the end of the two years.
“But if you wait and the base rate (and savings rates) rise by 0.25 percentage points, you’d make an extra £51 in interest.
“If Base Rate rises to 1.25% and all that gets passed on to savings rates you’d make an extra £204 in interest at the end of the two years.”
If you have a pension
Interest rate rises can also be good news for pensioners about to buy an annuity.
Annuities rates are link to the cost of government borrowing and pay a guaranteed income for life.
The income you receive can be locked in on the day you purchase your annuity, so current annuity rates can make a big difference to your long term financial security.
If you’re looking to buy an annuity, an interest rate rise can be very good news as it means you’ll probably get a better rate of return.
People who have already taken out an annuity can’t switch, but you can still benefit from better interest rates by putting the money from your annuity into a savings account with a better rate.
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This post first appeared on thesun.co.uk
