The Bank of England has imposed the biggest interest rate hike since 1995 in a bid to fight inflation, but is adding significant costs to borrowers in the process.
Consumer credit experts have told Sky News there are significant savings to be made by switching to a fixed rate mortgage deal and seeking higher savings rates after the bank rate – used to determine variable rate of return (SVR) mortgage repayments – has been increased to 1.75% by city policy makers.
It is the first time in more than a quarter of a decade that such a large increase, of half a percentage point, has been imposed after five previous, but more modest, increases since December.
It is closely following sharp rate hikes by the US Federal Reserve amid a warning from the International Monetary Fund that central banks should take an aggressive stance against inflation.
Why is the bank raising its interest rates?
This is all part of efforts to get inflation under control – currently at its highest level in 40 years – as part of the bank’s mission to bring inflation to a target rate of 2%.
The main measure of the consumer price index (CPI) currently stands at 9.4% and the bank now expects it to rise above 13%% this winter as energy price continue to climb across Europe due to Russian restrictions on gas exports to the continent.
Rate hikes are designed to remove demand from the economy, helping the steady pace of price growth to cool faster than it would otherwise.
I thought the bank couldn’t control energy costs?
It is not possible.
The bank’s big problem here is that the power shortage is a supply problem it can’t do anything about.
Its objective is therefore to accelerate the transition towards easing inflation, which, for example, has included calls for wage moderation.
The bank fears wage settlements in line with inflation, currently sought by many unions, making inflation even more tenacious to bring down.
So who is most affected by rising rates?
The simple fact of life is that if the bank rate goes up, so do the interest rates paid by businesses and individuals for loans, unless they are for a fixed term.
When it comes to housing, there are still around two million households under tracker and SVR, which collectively make up around a quarter of the mortgage market.
According to figures from industry body UK Finance, tracker customers now have to pay £171.47 more per month than they did when rates started to climb last December.
For SVR customers, the figure is £108.37.
What about fixed rate offers?
The cost is – inevitably – also on as the discount rate is rising.
However, the key thing here is that current fixed rate contract holders will not feel any pain until their contract expires.
According to financial product data specialist Moneyfacts.co.uk, the average five-year fixed rate had crossed the 4% mark before Thursday’s rate hike, from 2.6% in December last year.
He put the average SVR rate at 5.17%.
Moneyfacts said the difference between the average two-year fixed mortgage rate and the SVR deal was worth around £3,300 on average in savings per year.
According to UK Finance, around 1.3 million fixed rate transactions are expected to close this year at some point.
What about business and personal loans?
It is clear that banks generally require a better rate of return, but it all depends on the financial situation of the client as the risk levels will be different.
If borrowers are paying more, why aren’t savings rates keeping up?
The old saying goes that lenders are quick to punish but slow to pass on benefits.
Moneyfacts said average easy-access savings rates stood at 0.2% last December and 0.69% at the start of this week.
Given the rate of inflation, currently at 9.4%, the power to save remains well and truly eroded.
What can I do to protect myself from rising interest rates?
The advice is to research financial products from consumer groups, charities and switching services all offering help in finding the most suitable deals.
When it comes to mortgages, affordability criteria are crucial.
Moneyfacts financial expert Rachel Springall said: “Borrowers who haven’t locked in a fixed rate would be wise to act quickly to secure a new deal as interest rates continue to climb.”
She added: “The cost of living crisis, rising interest rates and rising property prices could weigh on potential buyers if they have little disposable income and then eat away at their savings.
“On the other hand, mortgage customers may find that they have more equity in their home, but will need to seek independent advice as to whether they can comfortably afford to change their agreement.”