Interest rates have a huge influence on homeowners across the United Kingdom. If you have a variable rate mortgage through a bank or financial institution, your monthly payments are heavily influenced by the base rate set by the Bank of England (BOE). Let's look at why this rate is so crucial and how it impacts your household budget.
What is the BOE rate?
The BOE rate is also known as the base rate or simply the interest rate. Set eight times a year by the UK's central bank, it influences economic conditions and commercial interest rates across the country. If you have a mortgage, any other type of loan, or even just a savings account, this rate has a direct effect on your personal finances.
For example, if you have a variable rate home loan, a higher BOE rate normally means your payments go up. The base rate currently sits at 5.25%, having grown steadily since late 2021. This is the highest rate since 2008 due to efforts by the BOE to slow down the economy. Higher rates increase the cost of borrowing, making goods and services more expensive and hopefully driving down inflation.
The BOE lends money to financial institutions all the time, and just like other lenders, it charges interest. The amount of interest is determined by the base rate, which also affects swap rates when banks lend to each other. Whether the base rate rises or falls, lenders normally pass changes on to consumers. Generally speaking, a lower base rate leads to lower commercial interest rates, and a higher base rate leads to higher commercial interest rates.
How the base rate affects your mortgage
A mortgage is a special type of loan used to purchase or maintain real estate. Under a mortgage contract, a borrower takes ownership of a property and agrees to pay for it over a set period. In most situations, the property serves as security, and a series of regular payments are made over time.
These payments are divided into two categories: the principal of the home loan and the interest charged. The former is the amount of money you borrow, and the latter is the cost charged by your lender to access this money. As the BOE base rate changes, most commercial lenders will also change their rates. However, the influence of these changes depends on the type of mortgage contract you have signed.
For a variable rate mortgage, any changes made will affect you immediately. For a fixed rate mortgage, a rate is set when the contract is signed and held for a designated period. Any changes to interest rates during this period will not affect you. A tracker mortgage stays in perfect alignment with the BOE base rate, with interest rates always reflecting BOE changes. This is different to variable rate loans, which may not track the BOE rate perfectly.
How interest rates affect existing and new borrowers
If you have an existing fixed rate mortgage, your current rate will expire at some point. If you have a variable or tracker mortgage, your interest rate could change at any time. In either event, it's important to be prepared to avoid blowing out your budget. Most fixed rate loans have an initial mortgage term, which is typically 2-5 years. At the end of this period, your home loan will probably revert to a variable interest rate set by the lender.
More often than not, this rate is much higher than your current interest rate. In most cases, it's also likely to be higher than the rate you could secure by arranging another home loan. Higher rates mean higher payments, and that's something no one wants to experience. Luckily, there are lots of creative strategies available to help reduce your monthly payments.
If you want to minimise your interest charges and get your household budget back on track, please contact our financial experts. We will discuss the pros and cons of various strategies and find something that's perfect for your home and lifestyle. Reach out to our team today for a confidential discussion.
Note: Your home can be repossessed if you fail to make mortgage repayments. The information contained in this article was correct at the time of publication, but it is subject to change.
