The Bank of England’s Base Rate: How Does it Affect You?
The base rate of the Bank of England, also known as the ‘Bank Rate’, is the most important interest rate in the United Kingdom. The base rate influences the cost of borrowing money, as well as the interest earned on savings accounts. As the base rate directly impacts the cost of your mortgage and other borrowing it is beneficial to understand how the base rate works, and how it affects you.
What is the Base Rate of the Bank of England?
The base rate is the interest rate set by the Bank of England which determines the cost of borrowing by other banks and lenders; it sets the level of interest that other banks and lenders charge. The Bank of England explains it as, “What you pay for borrowing money, and what banks pay you for saving money with them.”
How and Why do Rates Change?
The government will decide an inflation rate target (currently at 2%) that the Bank of England uses as a marker to determine the base rate, though it is the Monetary Policy Committee (MPC) which actually decides the rate. They meet eight times every year to re-evaluate the base rate based on how well the economy is performing.
The MPC has the ability to adjust the base rate up or down, based on the current economic circumstances in the UK. If there appears to be a need for increased spending and borrowing, perhaps in an effort to aid the economy, the MPC can lower the base rate. However, if borrowing or spending levels increase at an accelerated rate, the MPC can choose to raise the base rate to avoid inflation rising above the set 2%. Members of the MPC put this decision to a vote every time they meet.
The Bank of England records the changes in the base rate over time. Currently, it is historically low, and before March 2020, it hadn’t changed since 2018 . At the time of creating this post, it is currently set at 0.1% . Before this recent change, the base rate was 0.25%, a stark comparison to the near 15% it rose to in 1989!
Impact of the Base Rate on Mortgages
The impact of the base rate on your mortgage will depend on what type of mortgage you have.
Fixed Rate Mortgage: If you have a fixed rate mortgage, you will not be affected by the changes to the base rate if the MPC should change it. This is because, as the name suggests, your interest rate is fixed and thus unchangeable.
Standard Variable Rate Mortgage (SVR): Unlike tracker mortgages (see below) or fixed rate mortgages, having an SVR mortgage means your mortgage interest rate may be directly impacted by a change in the base rate. It depends on your lender. If the base rate increased by 1%, for example, your lender can choose to either maintain the interest rate originally given to you, increase it in accordance with the new base rate (or higher!), or, though highly unlikely, they may choose to decrease your interest rate. SVR Mortgage lenders can actually choose to increase their interest rate at any time and do not have to wait for the base rate to change before doing so, making an SVR a potentially expensive mortgage option.
Tracker Rate Mortgage: A tracker rate mortgage is similar to a variable rate mortgage, in that the interest rate can fluctuate. However, they differ because a tracker rate mortgage tracks an interest rate - in fact, they usually track just above the interest rate. This type of mortgage interest rate usually tracks the base rate of the Bank of England, meaning that a change in that rate will cause your mortgage interest rate to rise or fall. Your lender may change your rate on the same day of the base rate change, or they can choose to adjust it at the start of the following month.
Impact of the Base Rate on Savings Accounts
The base rate’s impact on your savings account will also depend on the type of savings account you have.
Fixed Rate Savings Accounts: As with a fixed rate mortgage (see above), the interest rate on a fixed rate savings account cannot change during the period in which you agreed to when you opened the account.
Variable Rate Savings Account: Your bank can change the interest rate of your savings account to the same, or by more or less than the base rate of the Bank of England. They may even leave it unchanged. Recently, banks have been lowering the interest rate on variable rate savings accounts, even when the Bank of England left the base rate unchanged. While this is not the case with all banks, make sure that you check your interest rate regularly to ensure you are receiving the highest you can.
Tracker Rate Savings Accounts: Like tracker rate mortgages, the interest rates on tracker rate savings accounts will adjust according to the fluctuations in the base rate.
What Can You Do if the Base Rate Changes?
A base rate change will have positive and negative implications for almost everyone. A decrease in the base rate may make mortgages cheaper unless you are on a fixed rate mortgage, but you will receive less interest on your savings; an increase in the base rate would mean good news for savings account holders (unless your rate is fixed), but those with variable or tracker mortgages would end up paying more for their homes.
In these uncertain times it is important to understand how a change might impact you, allowing you to plan ahead where needed.
If you require assistance regarding a financial decision, it’s always wise to speak to a financial advisor.