An interest rate is the cost of borrowing money or the return on investment for lending to others. It plays a crucial role in the financial system, informing the cost or reward of products such as loans, savings accounts, mortgages, and investments.

Here’s a breakdown of how interest rates work in personal finance: 

1. Economic indicators: 

• The Bank of England’s Monetary Policy Committee (MPC) sets the base interest rate for the UK economy. Changes in this rate have a ripple effect on other interest rates. For example, when the base rate is lowered, banks tend to lower their lending and savings rates, making borrowing cheaper but reducing returns on savings and vice versa. 

2. Borrowing money: 

• Loans: When you borrow money, such as through a personal loan or a credit card, the interest rate is the percentage that the lender charges you on top of the principal amount borrowed. This is the cost of borrowing money, and it’s typically expressed as an annual percentage rate (APR). The APR includes not only the interest but also any additional fees associated with the loan. 
• Mortgages: When you take out a mortgage to buy a home, the interest rate determines how much you’ll pay over the life of the loan deal. Mortgage interest rates can be fixed for a certain amount of time (usually two, three or five years) or variable (changing periodically, usually in relation to the Bank of England’s base rate). 

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3. Saving and investing: 

• Savings accounts: When you deposit money in a savings account, the bank pays you interest on your savings. This interest is typically lower than the interest rates on loans because you’re essentially lending your money to the bank. Savings account interest rates can be variable or fixed. 
• Investments: In the context of investments, interest rates can affect various financial products. For example, bond yields are influenced by prevailing interest rates. When interest rates rise, bond prices tend to fall and yields rise. Additionally, the return on savings and investment products such as Individual Savings Accounts (ISAs) is influenced by interest rates. 

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Q. OVERPAYING THE MORTGAGE: My partner and I bought our first home last year in July. We were lucky to get a five-year mortgage with a sub 3% rate. But a year on we’re worried that house prices are falling, leaving us with negative equity.

We’re also worried that in five years we’ll be stuck having to pay a higher rate as it’s unlikely we’ll get such a cheap deal again. But because we’ve still got time to spare, is it worth overpaying the mortgage to keep our heads above water? Our provider allows us to overpay by 10%. 

A. Fixed-rate mortgages are expected to come down in price once inflation returns to its 2% target and interest rates have peaked.  

However, the days of rock-bottom rates have gone for good I am afraid so while you still have four years left on your fixed rate (well done you for having the foresight to fix for that length of time on what has turned out to be an excellent rate), it is important to plan ahead to ensure you can cope. 

Overpaying the mortgage is a good way of reducing your outstanding debt and therefore the interest you pay.  

Most lenders will let you overpay by up to 10% per year without paying a penalty, as indeed your lender does, so if you can, take advantage of this. But make sure you don’t exceed this amount or you will be charged a penalty. 

However, before you start overpaying the mortgage, make sure you keep some money back to cover emergencies. It may be tempting to plough it all into the mortgage but money overpaid on the mortgage can be very difficult to get hold of again.  

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Keep enough cash in an easy access savings account to cover around six months’ worth of living expenses (the exact amount will depend on your attitude to risk and what you are comfortable with).  

Also, if you have outstanding debt such as on expensive credit cards, overdrafts or personal loans paying much higher rates of interest it is sensible to pay these off first before reducing your outstanding mortgage. 

Keep a note of when your fixed rate expires and get in touch with a whole-of-market mortgage broker six months before then in order to shop around for another deal.  Most lenders will let you lock in a new rate six months before you need it to begin. 

Mark Harris is chief executive of SPF Private Clients and was part of the launch team of the company as Savills Private Finance in May 1997. Originally launching as the financial services arm of Savills PLC, SPF has rapidly grown into one of the market leaders in UK financial services.  

Photo Credits: Pexels

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Chancellor Jeremy Hunt sat down with big banks last week to hash out a new ‘mortgage charter’ deal to protect homeowners with loans from soaring rate hikes.

Hunt has pledged to take action on savings rates too, and it is now widely recognised that High Street banks simply aren’t passing on rates quickly enough.

While it would be easy for Mouthy Money to claim a victory of sorts after our vocal campaign on this issue, we don’t believe the solution has yet been found.

It is now essential that the Government either legislate or use other binding methods to coerce the savings sector into accepting that firms MUST pass on rates as soon as the changes feed through from the Bank of England, in the same way that already happens for mortgages and other debt product such as credit cards.

Setting a rule, for example, that prevents banks from increasing debt product rates unless they also increase their savings rates, would be a good start.

This must happen as soon as possible to protect the economy from the ravages of inflation.

At the core of this is rewarding savers for not spending their cash. While the mortgage market is large, not everyone has access to it. But everyone is a potential saver, given enough incentive from their savings interest rate on offer.

If, as a country, we truly want to tackle the bane of inflation then the Government must act now to stop savers from the raw deal they have been given for so long.

Instead of simply punishing debt holders, we must collectively reward those who wish to save for the long term. Not only will this help the battle against inflation, but it might also encourage a new generation of savers, which in and of itself could be the solution to some of the UK’s longest-term financial woes.

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British savers should be earning up to twice the interest they currently are on their savings, Mouthy Money can reveal.

In a fresh blow to savers, damning new evidence uncovers how banks are routinely underpaying customers, despite interest rates recently hitting a 15-year high.

Data compiled for Mouthy Money by Moneyfactscompare.co.uk show how banks are paying up to half the interest they were in November 2008 – the last time Bank of England Base Rate was at its current level of 4.5%.

The revelation will heap further pressure on banks, which have been accused of profiting from the recent spate of interest rate hikes at their customers’ expense.

‘Vote with your feet’

Experts have urged savers to “vote with their feet” and ditch low-paying providers for those offering higher rates of interest.

Laura Suter, head of personal finance at investment firm AJ Bell, says: “As more people vote with their feet and shift their savings to a better-paying account, banks will face more pressure to raise rates to keep customers.”

The BoE has hiked interest rates 12 times in 16 months, leading to hopes of a better deal for savers after more than a decade of measly rates.

However, savings rates haven’t risen by anywhere near as much as official interest rates over the same period. This has led to accusations that banks are taking advantage of the fact their customers rarely switch accounts.

Moneyfactscompare.co.uk’s data shows how banks are paying much lower rates of interest to savers than they were 15 years ago. This is despite the fact official interest rates are at the same level now as they were back then.

For example, the last time official interest rates were 4.5% the average easy-access account paid 3.73%. Today it pays just 2.19% – some 1.54 percentage points less.

It means someone with £10,000 in an easy-access account is earning £154 a year less, on average.

Raw deal

The problem is not isolated to easy-access accounts, with savers earning significantly less across all product types.

Savers willing to lock their money away for 12 months currently earn an average of 4.18% a year – 1.61 percentage points less than in 2008.

Similarly, savers holding their cash in three and five-year fixed rates are on average paid 1 and 0.55 percentage points less, respectively.

Those worst off are holders of easy-access ISA accounts. According to Moneyfactscompare.co.uk, these savers earned 2.42 percentage points more on their money 15 years ago than they do today.

While banks are not obliged to pass on interest rates rises in full to savers, experts widely agree they are leaving their customers short.

MPs on the powerful Treasury Select Committee (TSC) recently called on banks to explain why they have been dragging their heels when it comes to passing on rate rises to their savings customers.

Calls for action

The calls for action have become deafening since it emerged that the UK’s biggest banks reported bumper profits in the financial year just gone.

A recent investigation by Mouthy Money revealed how banks made those profits by charging mortgage borrowers higher rates and underpaying their savers.

Hargreaves Lansdown, the investment company, calculated recently that savers are missing out on £23bn a year because banks are refusing to pass interest rate hikes on in full.

Experts claim banks were more readily willing to pass interest rate rises onto savers in the past than they are today.

Rachel Springall, personal finance expert at Moneyfactscompare.co.uk, says: “Base Rate is not as intrinsically linked to savings accounts as it was many years ago. Whilst there are some deals that rise in line, there are many providers that offer savings products which can see the interest rates offered rise or fall depending on their deposit targets.”

Suter says: “Banks respond to two forces: the Base Rate and competitors. They will use Base Rate as a gauge of whether to raise their savings rates, but of much more importance is what their competitors are doing.

“No bank is going to hike rates dramatically above the highest rival, as they only need to nudge it slightly over their competitor’s offering to win business.”

Pressure building

Regardless, MPs continue to apply pressure on the banks to boost the rates they pay savers.

Recently, Harriett Baldwin, chair of the TSC and the MP leading the charge against the banks, said: “Recent results announcements show that the UK’s biggest banks are continuing to squeeze record profits from their loyal savers.

“In a high interest rate environment, and with further Bank of England base rate rises possible, banks must do more to encourage saving.”

She added: “Consumers should continue to vote with their feet and find better offerings. This, more than anything, will drive the banks to increase their currently measly rates.”

A spokeswoman for UK Finance, the trade body representing banks in the UK, says: “Banks take a number of factors into account when determining the interest rate paid to savers or by borrowers. The Bank of England’s official ‘Bank Rate’ is only one factor. Other factors include the cost of raising funds, both in the retail and wholesale markets, capital and liquidity requirements, customer and regulatory expectations and the fact not all borrowers will fully repay loans.

“There is a wide range of cash savings accounts on the market and the interest rates offered are set by individual banks in competition with each other. The level of competition in the market is a key factor, alongside the nature of a bank’s own business model and customer strategy.”

How savings rates compare now versus November 2008

Source: Moneyfactscompare.co.uk; Rates based on £10k savings pot and are correct as of 30/05/23

Photo Credits: Pexels

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On Thursday, the Bank of England’s (BoE) Monetary Policy Committee (MPC) will meet to decide whether or not to increase interest rates

Since 16 December 2021, the MPC has hiked rates 11 times, from a record low of 0.1% to a 14-year high of 4.25%.

If you have a mortgage, particularly one that tracks base rate, you will have noticed the largest UK banks have been quick to pass higher interest rates onto you.

It’s a different story when it comes to savers.

Savers are being left with little to show for their efforts as big banks seem to have no interest in passing on those sizeable interest rate hikes to their customers in full. Here at Mouthy Money we think its about time someone found out why.

A comparison of the big banks’ easy access savings accounts – that don’t come with short-term bonuses or require some sort of subscription – show that the best rate on offer is just 1.29% from HSBC.

This is 242 basis points (bps) lower than the current market best buy from Chip (3.71%), and 296bps lower than the current Bank of England base rate of 4.25%.

The Bank of England has hiked its base rate substantially in the past 16 months, but the comparison lays bare the slow pace at which high street banks follow this up with easy access savings accounts.

Rachel Springall, finance expert at Moneyfactscompare.co.uk comments: “Convenience is costing savers who keep their cash stashed in an easy access account with a big high street bank. As the Bank of England base rate has risen all the way up to 4.25%, it is evident loyal savers have not seen the full benefits passed on to them.

“Savers who compare the top easy access rates will find they currently pay 3% or more, and every brand has the same protections in place as the big bank brands do, being covered by the Financial Services Compensation Scheme (FSCS). However, every institution can have its own reasons and margins in place that leads it to assess its savings rates.”

What’s more, higher interest rates are filling the banks’ coffers.

In their financial results, banks report something known as a “net interest margin”, which is essentially the difference between the interest it is making from borrowers compared to the interest it is paying savers.

The figures show that that margin has risen significantly since interest rates started rising. In other words, it means banks are passing on rising interest rate hikes faster to borrowers than they are savers — and profiting as a result.

The worst offender is Barclays Bank which now has a net interest margin, as of its 2022 full-year (FY) results, of 3.20%. The best is HSBC with 1.48%.

This failure to pass on interest rate hikes in full has not gone unnoticed. On 12 April the financial watchdog the Financial Conduct Authority (FCA) wrote to MPs in response to an enquiry from the Treasury Select Committee on why these rates are not increasing as might be expected.

The regulator points out there has been a “material time lag” between how quickly banks hike mortgage rates compared to savings rates.

Commenting on the correspondence, Harriett Baldwin MP, chair of the Treasury Committee, said: “The regulator has now given us official confirmation that the UK’s biggest banks are profiting from interest rate rises and that loyal savers are being increasingly harmed.

“While it’s welcome to hear the financial regulator is monitoring this situation, we will be keeping a close eye to ensure they act on these assurances. Consumers should continue to shop around to get the best rates possible.

“With banks set to release their first quarter results in the coming weeks, we will be monitoring whether firms are continuing to squeeze profits from their loyal savings customers.”

Photo by Expect Best from Pexels.

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Credit cards have a bad reputation, and the truth is when they aren’t used correctly, they can easily become a bit of a money trap.

Carrying a credit card balance is a lot more common than uncommon nowadays, with the average UK adult carrying around £3,724 in debt according to The Money Charity.

For those who are unable to pay off their credit cards in full at the end of every month, having a credit card can very quickly become expensive.

So, does it ever make financial sense to have a credit card? Should we avoid them altogether? The answer is, it depends. Here are some examples of when it may and when it may not make financial sense to have a credit card.

Credit Cards (Red X)

1. Spend more than you earn – If you spend more than you earn, unfortunately it will be pretty much impossible for you to pay off your credit card every month. Inevitably, you will be subject to paying expensive interest on the balance you owe.
2. Minimum payments only – If you can only afford the minimum payments, you’re pretty much in a trap. The credit card company has you right where they want you, paying them money every single month while your balance decreases extremely slowly.
3. Impulse buyers – Credit cards are very tempting and sometimes you can make yourself forget that it’s not your money you’re spending (been there, bought the T-shirt). If you are tempted to impulse buy when you go shopping or when browsing online, it’s probably best to stay away.
4. Forgetting to make payments – If you are someone who doesn’t like to automate and set-up direct debits, then it is very easy to forget when your credit card bill is due. Not only will you be penalised by the credit card company with a late fee, but it can also have a detrimental effect on your credit score. And once something hits your credit report it takes YEARS to come off.

Credit Cards (Green Tick)

1. To build credit – This is one of the reasons some people are encouraged to get a credit card to begin with. It can be a great tool to build credit as lenders like to see someone’s credit history to see if they are a responsible borrower. If you use your credit cards well, i.e. pay them off in full each month, it makes a strong case that you can handle credit appropriately.
2. Big purchases on sale – We’ve all been there. Sometimes making a big purchase is unavoidable, whether that’s a piece of furniture or an appliance, or maybe its currently on sale for a much better price than normal. But sometimes we simply don’t have all of the cash to pay upfront for it. Credit cards can be useful in this instance and help bridge the gap, especially when you know you will be able to pay off the credit card soon after without accruing any interest payments.
3. Protection – Credit cards are generous with the protection they offer on purchases. Sometimes they even offer travel insurance when you book a holiday with your credit card (check your terms). Section 75 refunds are applicable on purchases over £100 so can offer some significant protection in the event something goes wrong.
4. Points – Some credit cards offer points to their customers for making purchases with their credit cards. These points can then be converted to cash, vouchers, or avios for instance, which means you’re getting a reward for a purchase you were going to make anyway – big win! It is worth doing your research before diving into credit card rewards though, as often these days the benefits aren’t as good as they used to be.

In summary, credit cards aren’t necessarily awful, and can be pretty useful to many. But again, it very much depends on your personal circumstances, your relationship with money, and how disciplined you are to use it within your means.

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