Interest rates have just gone up for the 13th time in a row, in a bid to tackle the UK’s stubborn inflation.
The Bank of England has raised the central rate from 4.5% to 5%. That’s a steep increase of 0.5% – here’s how that will affect your finances.
Why is this happening?
Well, inflation in the UK is proving to be exceptional sticky – even when compared to other major economies in Europe and the US.
At the moment it’s at 8.7%, a rate it’s been at for two months straight. This rate is too high, driven by high food costs and soaring inflation for the services industry.
While there was hope that the UK economy would show signs of recovery in June, the latest data from the Office for National Statistics shows inflation isn’t going down, and UK net debt has passed 100% of GDP for the first time since 1961.
This is the result of Brexit-linked costs; the Ukraine war making fuel, fertiliser and grains more expensive; weather problems from countries we import from; and a labour shortage triggered by the Great Resignation during the Covid-19 pandemic.
How do interest rates change inflation?
Inflation is too high, and it’s the Bank’s job to bring it back down to the target rate of 2% – that is seen as high enough to get the economy growing, but not so high that people end up with sky-high living costs.
Interest rates are the main way for the Bank to control inflation.
Inflation is the rate at which prices for goods and services in a country change compared to the 12 months before.
Interest is the amount paid by those who took out the loan. It means borrowing money becomes more expensive and therefore people (in theory) spend less – so prices come down.
But, after 13 consecutive interest rate rises, this hasn’t really happened yet.
What does that mean for your finances?
If you have savings, they will be earning more in the bank – but the value of them will be eroded.
If you have a loan – particularly mortgages – you’ll have to pay more, especially if you have a variable or tracker mortgage.
As Money Saving Expert Martin Lewis explained last year: “For each one percentage point your mortgage rate increases, expect to pay roughly £50 more a month (£600/year) per £100,000 of mortgage debt.”
Think tank, the Resolution Foundation, estimates that by the end of 2026, households will be spending an average of £2,000 more a year on their mortgages compared to the end of 2021.
BBC More or Less explained on Twitter: “Every month hundreds of thousands of deals expire, and hundreds of thousands of households get exposed to higher interest rates. Unless interest rates suddenly come down, this ticking time bomb is going to keep going off, month after month.”
The interest rates therefore mean rent rates are likely to go up, as landlords look to cover the extra costs from the mortgages.
And, with experts discouraging wage increases, it’s likely that most households will have much less disposable income.
What shouldn’t you do during this economic crisis?
Firstly, don’t panic – try to stick to your budgets and current plans.
If you have a mortgage...
Do try to speak to your mortgage lender as soon as possible about what these interest rates mean.
If you’re on a fixed rate, variable or tracker mortgage, it’s important to know what options are out there when it comes to paying the money back.
For instance, you might be able to extend your mortgage term or move to an interest-only mortgage to alleviate the current squeeze.
If you’re looking to buy for the first time...
Buying in this economy is certainly difficult, but not impossible.
The key thing is mulling over whether or not you need to do it right now, especially as the Bank suggests interest rates will fall to 3.5% by 2025.
But, obviously this isn’t a guarantee, so it’s worth mulling over your options and talking to specialists when you can.
If you’re renting...
Your landlord might hike up your rent to try to cover the additional costs coming from their mortgage repayments.
However, they can’t do this more than once a year without your agreement if you have a rolling tenancy.
If you have a fixed-term contract, they can only increase it if you agree to it, or if it’s in your contract.
If you decline any increases, the landlord can wait until your tenancy is up to hike up the price.
Speak to Citizens Advice if you think your rent has been unfairly increased.
If you have a credit card...
Rates on credit cards are variable in most cases, so will change occasionally. Some banks link it to the base rate, but you should get 30 days’ notice if the rate is going to change.
Rates are already getting worse, so if you get a new card now it’s likely to have a higher interest rate compared to one you may have got a year ago.
Make sure you pay off the minimum payments on your cards on time every month, to keep your credit score up.
Most cards have a 21-day grace period, according to Salman Haqqi, personal finance expert at money.co.uk, before you have to start paying interest rates.
It’s worth using your savings to pay off these debts if you need to, because the interest rates on the money you have in the bank will have less impact than the interest rates on any borrowed money.
It won’t be enough to match or exceed inflation.
If you want to take out a loan...
As MoneySavingExpert.com advises, only borrow if you need to. But, if you find yourself in that situation, try to pay it back as soon as you can.
These rates are usually fixed, which prevents them from being too vulnerable to fluctuations in the economy, but check this with your lender before signing up to a loan.
Try to stay savvy too – sometimes the best rates come from higher loans, and sometimes it’s cheaper to overpay or settle your loan early for free, rather than spreading it out over a really long time.
If you have savings or investments...
You can get more from your savings by shopping around, and making sure you get the best interest rates available.
In terms of investments, don’t panic and drop everything – instead, stay investing in stocks and shares if you can weather the storm long-term.