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What would an interest rate rise mean for you and your wealth?

As inflation continues to rise, there is growing speculation that the Bank of England (BoE) will increase its base rate (in fact, by the time you read this it may have already happened).

The base rate is often called the interest rate and commonly sets the level of interest that all other banks charge borrowers.

For many months, this rate has been at a historic low of just 0.1 per cent. However, in response to inflation rising, the BoE is expected to increase initially this rate to 0.15 per cent in the coming weeks, before rising to 0.25 per cent next year and eventually returning to the 0.75 per cent rate last seen before the pandemic.

This action will only be taken by the BoE and its Monetary Policy Committee if they feel the need to control inflation.

How this affects you and your wealth will rely on many different factors, which we have outlined below:

Property ownership

The greatest concern from an interest rate rise is that mortgage holders wouldn’t be able to meet the additional costs.

Although most mortgages are offered based on an affordability test (which includes a stress test, should rates rise to 6-7 per cent) there are concerns, given the weakened financial position of many households, that borrowers may struggle.

Understandably, some lenders have already started raising interest rates as a result of the speculation, potentially bringing an end to the ultra-low-cost fixed-rate mortgages that many homeowners enjoy.

This is a big issue, as around a third of adults have a mortgage, with most people seeing it as their biggest monthly cost.

A rise in rates, even one that is slow and measured as many experts predict, could have an impact on your ability to save and invest.

At the moment around 74 per cent of mortgage borrowers in the UK are on fixed-rate deals. This means that they will only see an increase in interest rates once their deal ends and they either continue on a standard variable rate or remortgage to a new deal.

The remaining UK mortgage holders are either on tracker deals (roughly 850,000 homeowners) or an SVR (1.1 million homeowners).

These borrowers could see an immediate increase in their borrowing costs should the base rate increase.

According to UK Finance, if their rates mirrored a Bank rate rise to 0.25 per cent from its current level of 0.1 per cent, then a typical tracker mortgage customer’s monthly repayment would go up by £15.45, while an SVR customer would have to pay an additional £9.58 a month.

However, to protect themselves some lenders may raise their rates beyond the base rate. For example, if lenders raised their rates by one per cent the average tracker customer would pay £93 a month more and an SVR borrower would see costs increase by £57 a month.

Borrowing

People looking to borrow via a credit card, loan or through an overdraft are also likely to see the rate of interest that they pay increase if the base rate were to rise.

Many individuals have relied on cheap credit in recent years given the historically low rates of interest, especially with many products offering a long zero-interest payment period.

However, as rates rise the cost of borrowing will increase, which may mean that now is the time to consider paying off debts that have been accrued so that your wealth generation isn’t constrained by the need to pay interest.

Saving

Logic would suggest that as interest rates rise on borrowings, so must they rise on savings as well.

Unfortunately, banking analysts believe that if the base rate were to rise, there would be no guarantee that saving rates would increase as well (at least not initially).

They point to the fact that saving rates have continued to fall at a consistent rate regardless of whether the base rate increases or not.

At the moment, most savers are receiving pennies in interest for every £100 they save, leading some experts to suggest that cash savings accounts are no longer useful for wealth generation and are seen more by savers as a way of securing their money.

In fact, data suggests that most savers are completely switched off when it comes to saving, with many people not even knowing the rate of interest on their current savings account.

Investments

Although a rate rise may not have much of an impact on cash savings, it may have more of an influence on the value of stocks and shares.

Historically, some shares tend to perform better than bonds when rates rise. This is especially true for shares linked to other companies’ borrowings.

Conversely, shares or investments in businesses that are indebted tend to perform less well, even in the case of some high growth tech companies, as investors fear the impact that the cost of servicing debts may have on the business.

If you are concerned about future interest rate rises and their impact on the preservation and generation of wealth, you should seek independent financial advice.

Link: How would an interest rate rise affect you?

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