Interest rate rises - what it means to you

With the cost of living predicted to be on course for a 30-year high, it may seem the recent interest rate rise could not have come at a worse time. So why have interest rates gone up in the UK? And more importantly, what can you do about it?

• Why have interest rates gone up in the UK?
• How do the interest rate rises affect loans?
• How do the interest rate rises affect credit cards?
• How do the interest rate increases affect my savings?
• Will interest rates go up again?
• What can I do about the interest rate increase?

Why have interest rates gone up in the UK?

Raising interest rates helps control inflation. Inflation is the rate at which prices for goods and services rise. For example, if a bread loaf costs £1.00 and rises by 10p to £1.10, the bread inflation rate is 10%.

Prices, in general, have risen recently due to increased demand for goods and services, such as electricity and gas. There have been supply issues, particularly in the transport sector, manufacturing and general staff shortages. More recently, the conflict in the Ukraine and sanctions imposed on Russia have further increased energy and fuel costs.

These factors combined have increased demand, pushing prices up, and the inflation rate in the UK has risen higher than expected. High inflation means wages decrease in value, and households get less for their money.

Usually, when interest rates increase, the economy slows down, and inflation decreases because people are more likely to save money than spend it. People save money to benefit from the better returns on savings. They are also less likely to borrow more money as this will cost more. When economic growth is needed, the opposite is done, interest rates are decreased to reduce the cost of borrowing.

The Bank of England raised interest rates to 0.5% in early 2022 to stop inflation from getting out of control. The previous interest rate was 0.25%, the second increase in the last three months. The Bank of England (BoE) has a target inflation rate of 2%. In the 12 months to December, inflation rose to 5.4%. The BoE estimates this may reach 7% in the coming months. However, this estimate was made before the war in Ukraine.

The BoE interest rate is often referred to as the "bank rate" or "Bank of England base rate". A Bank of England base rate increase means financial institutions are charged more to borrow money and paid more to save. Changes to the base rate influences interest rates as a whole in the UK, affecting lenders, banks and other forms of credit. So, if you are paying off a mortgage or planning on borrowing money for a car, you may be affected.

How do the interest rate rises affect loans?

If you have a mortgage with a variable interest rate or a "tracker mortgage", it's likely that you will see an increase in cost as this type of mortgage more or less follows the Bank of England's base rate changes. If you have a fixed-rate mortgage, you won't see changes until the end of the fixed period or term.

For example, a mortgage loan to the value of £100,000 with a 25-year term on an interest rate of 3% will cost £474.21 a month. If your lender decides to increase the interest rate to 3.5% to follow the base rate, monthly payments will increase by £26.41, or £500.62 a month.

UK lenders will likely adjust rates on other types of debt, such as personal loan interest rates. Taking out a personal loan after a base interest rate increase may well be more costly. However, changes may take some time to take effect, and it is up to the lender.

If you are currently paying off an unsecured personal loan, you will likely be on a fixed interest rate, which means your repayments will remain unchanged. Secured loans with a variable interest rate, as with some car loans, will follow base rate changes, and this will mean higher repayments.

How do the interest rate rises affect credit cards?

Credit card providers will likely review their interest rates when there are base rate changes and decide if they want to make changes. If you have an existing credit card and your provider decides to increase your interest rate, they are required to let you know about the change 30 days in advance. If you disagree with the new rate, you should have 60 days to pay off your existing balance and cancel your card without being charged the new rate.

Any changes to your interest rates should be explained clearly, with costs included and options available to you. A credit card provider should not increase your interest rates more than once in six months unless there have been exceptional circumstances.

In recent months it has been reported that interest rates charged on credit cards have sharply increased to an annual average of 21.49% in 2021. So if you are looking to apply for a credit card, it's good to do some research, shop around and compare what's available.

How do the interest rate increases affect my savings?

Bank of England base rate increase should mean you earn more interest on your savings, but this will depend on your bank account provider and the type of savings account you have. However, you may have to be patient. Banks and building societies don't usually increase rates on saving accounts immediately, and the increase may not be the same as the base rate.

According to Anna Bowes (of Savings Champion), only slight increases in rates have been passed on to savers so far, and providers have been slow in passing on the benefits. The average interest rate on easy access savings accounts in early February 2022 was 0.19%, up from 0.17% in December 2021. As a comparison, in the past five years, the best easy-access savings rate was 1.6%, back in September 2019.

Will interest rates go up again?

According to the BoE's website they "may need to increase interest rates further over the coming months". Bank of England base rate is decided by the bank's Monetary Policy Committee. This committee meets eight times a year to determine if the base rate should or should not be changed. Before making such a decision, they will look at how the economy responds, keeping an eye on critical factors such as the price of energy, imports, wages, and spending.

What can I do about the interest rate rise?

If you are not affected immediately by the base rate increase, you may still want to take the opportunity to review your finances, even if it is to try to save more and benefit from improved rates on savings. It's good to look at your finances regularly and to plan ahead. Also, be prepared to cut back more on spending and make sacrifices. Here are a few tips worth thinking about:

Start a realistic budget plan now:

It's worth putting more away as better saving rates will start to come into the market. If you struggle with the thought of budgeting, we have put together a guide on how to make budgeting simple and fun.

Look for mortgage deals:

Start by checking if interest is fixed, variable or if you are on a tracker, as well as the term or duration of the agreement. Then decide what options will best suit you when the time is up. You can use the Money Helper Mortgage Calculator to try out different interest rates to work out monthly costs. A mortgage advisor will also be able to assist you.

Try to free yourself of high-cost debit:

If you have other forms of debt, you may want to start paying off the most expensive ones first, such as short-term loans. If you have a high credit card balance, you could also look at zero balance transfer credit cards. These cards allow you to transfer an existing credit card balance for a fee. You will get a set time where the same balance is not charged interest.

Look for better interest on savings:

If you have savings stashed away, check how long your term lasts and the interest rates. Then, compare savings accounts to see what is available, that way, if needed, you can switch to an option that gives you more for your money at the appropriate time.

Look after your credit score:

If you are planning on borrowing money soon (for example, buying a car or a house), then be sure to monitor your credit report and try to improve your credit score where needed.

Understanding what is a good credit score in the UK is important. A better score will make you more attractive to lenders and open more deals, including lower interest rates.

Take care when taking on additional debt:

Not making a repayment in full or on time will hurt your credit score, and that will have a knock-on effect on any future application to borrow money, phone contracts or if you are looking to rent a home. Even credit card debt can start to build up if your card balance is carried over from month to month.

If you know you struggle to control spending, you could consider using apps to help you manage your money or even getting a prepaid card to help you budget.

In summary

Interest rate increases are inevitable and not something we can control as individuals. What we can control is our personal finances and the decisions we make. Setting up a realistic budget plan and sticking to it is always a good place to start. Consider also knocking off expensive debt as quickly as possible, as the longer, you hold on to this, the more it will hurt your pocket.

Do your research and compare financial options as you more likely find suitable deals, get more for your money and make better financial choices. Finally, take a practical step to protect your credit score, and think twice about borrowing money, especially if you are in a tight financial spot. Only borrow when you need, and you know you can make repayments.