The Highs and Lows of Rock-Bottom Interest Rates
In early August 2016, the Bank of England finally made the announcement that had long been predicted and had been the topic of nearly endless speculation: a cut in interest rates to a new record low of 25 percent. Not surprisingly this decrease is generally considered to be good for borrowers (particularly those who have mortgages) and bad for savers. Accordingly it is a mixed blessing to the millions of UK residents who fall into both categories.
It is well worth your time to review your finances in order to determine how the rate cut – and other actions taken by the Bank – will affect you and your family, as well as your company if you are a business owner.
A multifaceted stimulus package
The interest rate reduction was part of a £170 billion monetary-stimulus package that was designed to ward off a recession following the Brexit vote. The Bank’s Monetary Policy Committee (MPC) had set a previous record in March 2009, when rates were cut to 0.5 percent, where they had remained for more than seven years until this latest decrease.
The Bank has also voted to expand its quantitative easing (QE) programme by £60 billion. QE entails the creation – “printing” – of money in order to buy bonds issued by banks. In theory this increases the money that banks have to lend into the “real” economy. The most recent expansion of the programme includes an extension to the corporate sector; an extra £10 billion worth of debt issued by other companies will be acquired in an attempt to boost liquidity.
In addition the bank has launched a £100 billion scheme to offer cheaper financing, the purpose being to enable banks to lend to more small businesses, whilst protecting their own profit margins. For many business owners, this could mean there’s never been a better time to take out a business loan.
Don’t take anything for granted
As indicated above, the effect of the new low interest rate on individuals and families will vary. Certainly the lower rates will benefit homeowners who have tracker mortgages, which are mortgages in which the repayment rate tracks underlying interest rates. For example, if you have a £200,000 repayment loan on a tracker mortgage, your monthly payment could decrease by £24.16 or, if it is an interest-only loan, by £41.66.
But as is the case with any contract, the devil may be in the small print, so be sure to review your contract with care (and a magnifying glass if need be). Some lenders have declared that they will not reduce rates beyond a certain level, and others use a rate that may not be congruent with that of the Bank of England. As well, more than half of the home loans in the UK are on fixed rates for a set term, and many of those homeowners will not benefit for a while. Even so, many mortgage holders as well as prospective homebuyers will realise a benefit from the new low rate.
For savers the picture isn’t nearly as rosy. Rates have been quite abysmal for years; as of the time of the announcement of the newest cut, the average interest rate on an easy access savings account is 0.6 percent. Should that average mirror a change in the Bank rate, this will drop to 0.4 percent. However, cuts aren’t automatic, as evidenced in the fact that many providers didn’t wait for a Bank of England rate change to cut the returns they offered. Overall, though, there seems to be a downward trend in returns on savings.
The news is also mixed for pension holders. The Bank’s stimulus actions won’t affect the state pension, but will add extra pressure on the deficits facing defined benefit pension schemes. People who are buying an annuity from their defined contribution pension pot may also get a worse deal.
Borrowers beware
It might be tempting to laud the low interest rate as the harbinger of some sort of borrower’s paradise, but a more restrained attitude is perhaps in order. Although many mortgage holders or those shopping for a mortgage may benefit, those in the market for other financial products such as personal loans aren’t automatically guaranteed the rock-bottom rates – particularly if they have less than stellar credit. For people with credit challenges, finding an affordable quick loan can sometimes be a discouraging task, one that probably won’t get any easier as a result of the Bank’s latest actions.
Moreover, a prospective borrower should weigh other factors besides interest rates. Additional fees and charges may apply, so user reviews – negative as well as positive – can be very helpful.
How low can it go?
As if the latest announcements weren’t enough to absorb, it appears that the Bank of England isn’t finished tinkering with interest rates. The Bank has confirmed that rates could fall again and head even closer to zero by the end of 2016. If that happens it will deliver yet another blow to savers.
The takeaway lessons remain the same regardless of whether the rates drop even more, hover at .25 percent or begin to rise. The onus is on savers and investors to remain constantly vigilant, adjusting their strategies to avoid excessive losses. This may mean changing banks, negotiating for better rates, or shuffling items in the investment portfolio. And while borrowers will almost certainly have new opportunities to benefit from ultra-low rates, they must also be careful not to get themselves into a situation where they will take a hit should those rates begin climbing again. This may not be an issue with short-term loans but it certainly can be with longer-term commitments such as mortgages.
Since there are so many variables, a scrupulous review of your personal and business finances is in order so you can figure out if and where you need to make changes. You may need the help of a qualified advisor, which is a worthwhile investment as it can save you money down the road.
To a greater or lesser extent we are all at the mercy of the Bank of England’s decisions. But staying informed, and acting upon reliable information, can help prevent anyone – saver, investor or borrower – from suffering major losses when the financial landscape shifts yet again, as it inevitably will.
