What could changing interest rates mean for you

Why do interest rates move and up and down? And what does that mean for your mortgage repayments?

Key Points

• The Bank of England charges interest to banks and building societies when it loans them money – and that’s called the Bank of England base rate – or Bank Rate
• That interest charge is then passed on to us when we borrow money for a mortgage from banks and building societies
• If you have a tracker or standard variable mortgage, your repayments will be affected by changes in the Bank Rate
• Right now, the Bank Rate is at a record low and future changes are likely be small and incremental

Being charged interest is part and parcel of borrowing money.

The Bank of England charges interest to banks and building societies at what’s called the Bank of England base rate, or Bank Rate.

That interest is then passed on to us when we borrow money from a bank or building society to take out a mortgage.

So if the Bank Rate is high, the interest we pay on our mortgages will be higher, if it’s low, as it is right now, the interest we pay will be lower.

1. Why do interest rates go up and down?

The Bank of England’s interest rates are set by their Monetary Policy Committee (MPC).

The MPC’s main job is to keep inflation, or the rate at which the cost of things increases, low and stable.

The MPC makes sure inflation stays close to a target set by the government. The current target is 2%.

It does this by looking at the Consumer Price Index (CPI), which measures the cost of a range of different goods and services that most people buy,

The main way the MPC can control inflation is through either increasing or reducing the Bank Rate.

2. What is the Bank Rate?

The Bank Rate is the rate of interest at which the Bank of England will lend money to domestic banks.

Broadly speaking, if interest rates are high, so is the cost of borrowing.

A high Bank Rate tends to discourage businesses and people from borrowing money. When this happens, they’re more likely to save money than spend it.

When this happens, demand for goods and services falls, which reduces the rate at which prices increase, causing inflation to fall.

When the Bank Rate is low, borrowing is cheaper. That means more people and businesses are likely to borrow money to spend.

Cheap credit means demand for goods and services increases, which pushes prices higher, causing inflation to rise.

The Bank Rate is currently 0.75%.

3. What triggers a change in interest rates?

If the CPI index goes up or down steadily and over a series of months, the MPC will respond and change the Bank Rate accordingly.

If inflation remains above the government’s 2% target for too long, the MPC will have to take action to bring it back down again. To do this, it will increase the Bank Rate.

The MPC has not said when this may happen, although in its most recent meeting it did say “modest” increases in interest rates may be needed in the coming years.

4. What do interest rate changes mean for your mortgage?

Not all borrowers and savers will immediately be impacted by a change to the Bank Rate.

If you have a fixed rate mortgage, the interest you pay will remain the same for the term of your deal.

If you’re on a two-year fixed rate loan, for example, the interest you pay will be set for two years.

That means there won’t be a change in your monthly mortgage repayments until it’s time to take out a new mortgage.

If you have a tracker or standard variable mortgage, your monthly repayments will increase by the same amount as the Bank Rate.

But don’t panic. Any increase to the Bank Rate is likely to be small and gradual, as the MPC won’t want to risk damaging the economic recovery.

The MPC typically increases interest rates by 0.25%. So if you have a £200,000 mortgage for example, an increase of 0.25% will add £24 to your monthly repayments.

5. Can interest rates go really high?

Many people will have heard of interest rate horror stories from the late 1970s or 1992.

But the situation was very different back then, with interest rates set by the government. As a result, they were more volatile.

Today, a panel of independent experts sets the interest rate.

On 16 September 1992, Black Wednesday, interest rates increased from 10% to 12%, then they rose again to 15%, but the Bank of England dropped interest rates back down to 10% the next day.

In contrast, today the MPC can only make changes at one of the eight meetings it holds during a year.

The Bank Rate is also much lower today at just 0.75% compared with 17% in 1979.

In the 1980s, more people were on variable rate mortgages. Today, the majority of homeowners are on fixed rate mortgages.

If interest rates rise and you find yourself struggling to pay your mortgage, contact your lender as soon as possible. They will work with you to help you find a solution.