Will the base rate rise destroy household finances?
After years of speculation, it’s time to find out if our money management can withstand (slightly) higher interest rates
It has finally happened.
After a decade of bumping along the bottom at emergency levels, the group of nine people that decides the base rate of interest for the entire country has upped it to 0.75 per cent.
By doing so, the Bank of England’s Monetary Policy Committee has unanimously concluded that the UK economy is in better health than it has been for years. Whether the rest of the city agrees, is another matter.
What is true, is that it has been such a long time since the last rise of a whole generation of earning, spending and saving adults that has no experience of what it means or how it could affect them. The rest of us have probably forgotten.
This isn’t the thin end of the rate rise wedge. The Bank has made it very clear it is in no rush to repeat the hike anytime soon, stating that “any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent.”
While we've been waiting for normality to return, experts have been warning that our personal financial affairs are so precariously balanced, so thinly spread, that even this minimal shift could see thousands of people pitched into the red.
So what happens now and will your wallet survive it?
Any interest rate change will affect two aspects of our personal finances most directly – the interest we earn on our savings and the interest we fork out for our debts. With mortgages by far the biggest debt most of us will ever have in our lives, even the smallest upward nudge to the base rate will be felt by those on variable and tracker rate deals.
“For the first time in a decade, interest rates have climbed above 0.5 per cent, pushing millions of young mortgage borrowers into unchartered territory,” says Ishaan Malhi, CEO and founder of online mortgage broker Trussle.
“There are more than three million people in the UK on variable mortgage rates who could see an immediate financial impact from the rate rise. For those who are on these rates, it's a good time to consider switching to another deal.
“The rising interest rates mean the average homeowner on a variable rate with £200,000 left to pay on their mortgage will see repayments increase by £300 over the course of the year."
Of course, those on fixed-rate mortgages have little to fear until their current deal runs out.
“The rise to 0.75 per cent is fairly moderate and borrowers have been enjoying record-low mortgage rates for some time now, so the immediate impact won’t be too severe,” says Shaun Church, director at Private Finance.
“However, when it comes to interest rates, the only way is up. It’s likely that longer-term fixed rate products will grow in popularity as borrowers seek financial stability. 10-year fixed mortgages provide a decade of immunity against rising rates and the average cost is relatively low at just 2.74 per cent, compared to 1.73 per cent for a two-year fix. However, they often come with early repayment charges if borrowers switch their mortgage deal before 10 years is up.”
Crucially, a world where interest rate rises is the norm, not the exception, and those with outstanding personal debts will need to shift their assumptions as the repayment demands start to rise.
“This might only be a quarter percentage point rise, but for those who are already struggling to meet monthly mortgage, loan and credit card repayments, it could be painful,” Alec Pillmoor, a personal insolvency partner at RSM warns.
“Last week, we saw personal insolvency levels rise to a six-year high, despite record employment levels and low interest rates. Unless those with problem debts start to get their finances under control, we may well see these numbers rise even further.”
Jane Tully, director of external affairs at the Money Advice Trust, the charity that runs National Debtline, adds: “For the first time in nearly 30 years, UK households are now spending more than they have coming in. Combined with slow wage growth and increasing living costs, interest rate rises like today’s will add to the challenges facing the many people already struggling.
“With advice agencies continuing to experience high levels of demand for their services, it is crucial that lenders, government and the advice sector work together to make sure people affected receive the support they need.”
Hit hard by years of painfully low rates on their cash savings, those with rainy day funds squirrelled away, might be fooled into thinking their luck is about to change. It probably isn’t.
“On a balance of £1,000, the 0.25 per cent rise equates to earning an extra 21p a month. And even with the rate rise, it could be months before savers see the new rate being passed on,” says Simon Longfellow, head of stepstoinvesting.com.
“As such, savers need to be aware of other options to make the most of their money. A combination of low rates and high inflation meant UK savers saw the buying power of their money fall by £30.3bn in 2017 alone. An alternative to holding it in savings is to invest it, but there needs to be more education around the benefits and risks involved in investing as naturally, people are fearful of what they don’t understand. At the moment many don’t feel confident enough to put their money in potentially higher yielding alternatives.”
“There may be some smaller building societies that would pass on the rise and so savers should keep an eagle eye on rates in the coming weeks as sometimes good deals don’t last long,” adds Gordon Andrews, tax and financial planning specialist at Quilter and Jon Greer.
This will require a behavioural change, as people are tending to stick with their current provider rather than shopping around. The FCA has recently found that only 9 per cent of consumers have switched their cash savings provider in the last three years.
“Annuities, which provide guaranteed income for life, fell out of favour following pension freedoms. However, the interest rate rise could be good news for those seeking a guaranteed income and who are on the verge of retirement," adds Andrews, who admits the knock-on impact on annuities may not be immediate.
“For people concerned that their pension pot won’t last people’s extended lives, annuities are a great option. It will be interesting to see if a rising rate environment will draw more people back to annuities.”
What happens next?
“At first glance, raising rates now looks something of a strange decision. Inflation is above the 2 per cent target, but not disastrously so and a large chunk of the inflation we’re seeing is down to higher oil prices – something beyond the Bank of England’s control,” says Ben Brettell, senior economist for Hargreaves Lansdown.
“Wage growth is relatively subdued, and the economy isn’t exactly overheating at the moment.
“The main argument for raising rates now is that it gives the Bank more room for manoeuvre when the next downturn hits. If interest rates are 1 per cent or more by the time the economy sails into stormier seas, policymakers will at least be able to cut rates a couple of times before cranking up the printing presses for more quantitative easing."