Metis AM
Rising interest rates and inflation have constantly been in the headlines over the past year. In October 2022, inflation reached 11.1%, its highest level since 1981. Since then, it has begun to fall, albeit more slowly than anticipated.
In an attempt to bring inflation back down to its target of 2%, the Bank of England (BoE) has followed suit with many other central banks by raising interest rates. At their May meeting, the BoE Monetary Policy Committee (MPC) decided to raise the base rate for the 12th time in a row, bringing it to 4.5%. This is a steep increase from the historic lows of 0.1% seen at the end of 2021.
In time, the expectation is that higher interest rates will help to bring inflation under control. Once this happens, it may be possible for the BoE to reduce interest rates again. But it can take time for these effects to be noticeable.
So, in the meantime, how could higher interest rates affect your finances? Read on to find out.
Mortgage rates could increase
The impact of higher interest rates on your mortgage will depend on what type of mortgage you have. Some mortgage rates are directly linked to the base rate, while others are less likely to be influenced by it immediately.
Tracker-rate mortgage
Tracker-rate mortgages are so named because the interest rate applied tracks the BoE base rate. This means that, when the base rate increases, your monthly repayments are likely to increase almost immediately to reflect the change. Often, the lender cannot raise your rate by any more than the base rate was increased by. Since in May the base rate increased by 0.25%, it’s unlikely (though not impossible) that your rate would increase by more than this.
Using the Which? mortgage calculator, if the interest rate on your £100,000 repayment mortgage with 25 years left to run increased from 4.25% to 4.5%, your monthly repayments would rise by approximately £14 a month.
Variable-rate mortgage
The monthly repayments for those on their lender’s standard variable rate (SVR) are also very likely to increase when the base rate rises. But, unlike tracker mortgages, lenders can raise or lower their SVR as and when they choose.
This means that the effects of the base rate changes are less predictable than with tracker-rate mortgages.
Some lenders offer variable rates that are slightly above the base rate, while some offer discount rates that are slightly lower.
It will be up to your lender to decide if, and by how much, your monthly repayments will increase following the base rate rise. They will usually write to you to give notice of any changes.
Fixed-rate mortgages
Fixed-rate mortgages are the most popular type of mortgage in the UK; according to a report by This Is Money, around three-quarters of UK borrowers are on fixed-rate deals.
If you have a fixed-rate mortgage, your monthly repayments won’t change until the end of your current deal, regardless of how the base rate changes.
If you are reaching the end of your fixed-rate term in the near future, you have two options.
- You could move onto your lender’s variable rate
- You could remortgage to a new fixed or tracker rate.
Both of these options are likely to lead to highly monthly repayments. Rising interest rates have meant that fixed rates are now much higher than they were two years ago. This Is Money reports that the average customer who is currently remortgaging at the end of a two-year fix could find that their rate has increased from 2.57% to 5.26%.
If you don’t remortgage before the end of your fixed deal, you’ll usually move onto your lender’s SVR. It’s more difficult to predict what this will be, as it’s the lender who sets this rate, but the Times has reported that the average SVR as of 2 June 2023 is 7.37%.
It’s often possible to lock in a remortgage offer up to six months before your existing deal ends. So, if you are concerned about the possibility of further rate increases within that time, it might be helpful to start looking for new deals now.
You might notice your savings are growing more quickly than previously
While interest rate rises might be bad news for borrowers, savers usually benefit from a higher rate of return on their cash savings accounts. It’s important to shop around though if you want to find the best deal, since, according to a report by Sky News, not all banks will pass on interest rate rises to customers to the same extent.
Moneyfacts shares that the best interest rate on an easy access savings account as of 31 May 2023 is 3.82%. While this is certainly much higher than the interest rates you may have been getting on savings back in 2021, it’s still some way behind inflation in the UK, which the Office for National Statistics reported was at 8.7% in May 2023.
So, even though it’s good news that the rate of return on cash savings has improved, there is still a risk that the buying power of your money could fall over time if you keep a lot of it in cash.
Stock markets could continue to be volatile
The stock market can react quickly to changes in the economy, including high inflation and high interest rates. So, while the increase to the base rate may not directly affect your investments, you might notice a knock-on effect on some returns.
When interest rates are high, consumers tend to spend less. This is partly because they can get a much better rate of return on their cash savings than previously, but also because the high cost of borrowing means most consumers are likely to have less disposable income. So, companies that are vulnerable to consumer spending habits might drop in share value if they record lower profits than expected.
Additionally, some companies may struggle to secure funding, because the cost of borrowing is higher than previously. This can affect their ability to grow as expected and produce the level of returns that you might have been expecting on a particular investment.
It can be nerve-wracking if your investments don’t perform as you hoped they might, but remember that fluctuations on the stock market are to be expected. Short-term turbulence is usually smoothed out by long-term performance, so try not to let the noise of the headlines convince you that you need to make changes to your portfolio purely because of interest rate rises.
Instead, keep in mind your long-term goals and focus on whether your portfolio is correctly balanced to give you the best chance of achieving those goals.
Your retirement income could be affected as interest rates rise
If you’re approaching or already in retirement, you may be concerned about how your pension could be affected by the rising interest rates.
The effect of the rate rises partly depends on how your pension is invested. Many pensions are at least partially invested in bonds, which often fall in value when interest rates increase. This could mean that your pension pot doesn’t grow as quickly as you might want it to during times of higher interest rates.
If you’re thinking of purchasing an annuity, you could benefit from higher rates. Annuity rates often rise in line with interest rates, so you could get a higher annual income from the annuity.
This can be a helpful way to secure a guaranteed income in retirement, but isn’t suitable for everyone and can’t be changed once you’ve purchased it. So, it’s important to consult with your financial planner before you lock in a deal.
Interest rates are likely to fall when inflation is closer to the 2% target
You might be wondering when interest rates are likely to fall, but sadly no one can predict what might happen next in the economy to be able to answer this question with certainty.
The good news is that the BoE MPC expects inflation to fall to around 5% by the end of 2023. As inflation falls, it’s likely that the BoE will reduce the base rate, meaning that subsequent falls in wider interest rates could follow.
Working with a planner can help you to protect your wealth from the effects of interest rate rises
Whether you’re looking to invest in property, buy a new home, or grow your wealth in anticipation of retirement, working with a planner can be a helpful way to make sure you take the appropriate action for your circumstances.
Your planner can help you to examine each area of your finances – from your mortgage to your investment portfolio – and help you to take proactive steps to protect your wealth from the effects of rising interest rates.
Get in touch
If you’re concerned about how interest rates could affect your wealth, we can help. Email enquiries@metiswealth.co.uk or call 0345 450 5670 today to find out what we can do for you.
Please note
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
