The impact of low interest rates on your mortgage choices
The bad news for savers and good news for borrowers looks likely to continue as the base rate is set to stay at its 0.5% record low for months to come.
While some economists expect the Bank of England base rate to rise – albeit marginally – in autumn 2011, others predict it will not budge for two years. A poll of 50 economists by Reuters puts base rate on hold until at least October 2011, when it could rise to 1%.
But there's a wide discrepancy between economists. Fionnuala Earley, senior economic adviser at RBS, thinks it will increase to 2% by April 2012. But Vicky Redwood, UK economist at Capital Economics, predicts that the current rate is here to stay until 2013.
It's a view shared by Andrew Goodwin, from the Ernst & Young ITEM Club, which bases its forecasts on the Treasury's economic model. He says: "We think base rate will remain on hold for the next three years if the government carries out its current policy."
Professor Andrew Clare from Cass Business School says: "Base rate is not going anywhere. The first rise in the US is not expected until 2012 and it is difficult for us to do anything before that."
Whoever is proven right, savers face another year of rock-bottom interest rates at a time when inflation is running ahead of the government's 2% target.
They can make the most of their money by picking top-paying new accounts launched to lure them in. Banks and building societies, keen to raise money from savers now the wholesale markets have dried up, have launched a stream of accounts paying nearly 3% before tax (2.4% after) as they compete for our easy access savings.
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The rates are typically boosted by a bonus, which lasts for the first 12 months, so savers need to switch when it runs out, or they could end up earning 0.5% (0.4%) or less. Fixed-rate deals pay higher rates. The best pay a lot more than the worst, so seek out top deals.
Kevin Mountford, head of savings at moneysupermarket.com, says: "The rates paid on new accounts are artificially high and I expect them to come down soon. But the rates on new cash Isas in the spring should offer good deals."
He adds: "Fixed-rate bonds are often priced against future market conditions. A three-year bond paying 4% before tax is not a bad option, especially if you need income from your savings."
Borrowers must decide whether to switch to a fixed-rate deal ahead of any interest rate rises. Capital Economics expects the average mortgage rate to stay around 4% until the end of 2012.
Housing recovery slow
But even if the base rate does rise sooner rather than later, the rise will not necessarily be passed on to borrowers.
That's because providers are offering rates at hefty profit margins, so they can keep mortgage rates low even if money markets swap rates or the base rate rises.
Sticking to a good variable-rate deal could still prove a cheaper option than switching to a fixed-rate deal now.
Cheaper fixed-rate deals, with rates cut by as much as 0.3 percentage points as competition for borrowers increases, are on offer. Fixed-rate mortgages have been unpopular in recent years because the headline rates on tracker deals, which follow base rate, have been attractive.
Ray Boulger, technical adviser at mortgage broker John Charcol, says: "Before the credit crunch, it was easy to see where fixed-rate mortgages were going. Now it is more difficult because lenders are more reliant on savers than wholesale markets when raising money, and demand for mortgages has slowed."
He thinks it's too early to switch to a fixed-rate deal to avoid rising interest rates. "I would dissuade someone from switching from a tracker mortgage to a two-year fixed-rate deal. If you want a fixed rate, go for a five-year term."
However, borrowers on a high-standard variable rate can benefit by switching to the best fixed-rate deals.
This article was originally published in Money Observer - Moneywise's sister publication - in January 2011
With a tracker mortgage, the interest you pay is an agreed percentage above the Bank of England’s base rate. As the base rate rises and falls, your tracker will track these changes, and so rise and fall accordingly. If your tracker mortgage is Bank of England base rate +1% and the base rate is 5.75%, you will be paying 6.75%. Tracker rates are lower than lender’s standard variable rate (SVR) and as they are simple products for lenders to design, they usually come with lower fees than other mortgage schemes.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.