What does the interest rate cut mean for you?
For five months on the trot the Bank of England's Monetary Policy Committee (MPC) has cut the base interest rate in an attempt to help households and businsesses weather the economic downturn.
In October, following signs that inflation had peaked the previous month, the MPC shaved 0.5% off the base rate to 4.5%. In November, it slashed 150 basis points off the base rate bringing it to 3%, while in December it voted for another cut, this time of 1%. In January, a 0.5% cut was voted on, bringing the base rate to its lowest level in the 315-year history of the central bank.
In February, the rate was cut a further 0.5% to just 1%, despite calls for a break from aggressive rate cuts.
It is hoped that such historically low interest rates will reduce the impact and length of the pending recession, and will ease pressure on cash-strapped consumers and businesses.
But according to data provider Moneyfacts, with each rate cut fewer lenders have passed on the benefits to borrowers while an increasing number of banks have hit savers by slashing AERs.
Michelle Slade, analyst at Moneyfacts, says: “With each base rate cut, the number of lenders passing the cut on in full to their SVR continues to dwindle. It is likely that some lenders have already cut rates as low as they are prepared to go.”
So, what does the latest cut mean for your finances?
Technically, rate cuts should be good news for borrowers. But it depends on the type of loan you have as well as your provider.
And Michael Coogan, director general of the Council of Mortgage Lenders, says it is doubtful whether the cut will help banks increase the amount they lend.
"IIn practice, rate cuts alone will not achieve this objective as they have become a more blunt instrument- they are only one of the tools being used to try to help the UK weather the recession," he adds.
And Adrian Coles, director-general of the BSA, points out that lenders might not be able to lower rates - even if they want to.
“Mortgage rates are determined by a number of factors, not just the base rate," he says. "These include trends in money market rates and the requirement to fund part of the Icelandic and Bradford and Bingley bailouts, while many mortgages also feature collars that will prevent mortgage rates mirroring base rate cuts."
Rate is not the only factor restricting people's ability to borrow. Miles Shipside, commercial director at Rightmove, says: “We have found that despite the doom and gloom, the majority of consumers hope to buy in the next year, though today’s cut is relatively insignificant to most prospective buyers, as reluctant lenders are placing other hurdles in their way.
"Lack of mortgage funding is the issue, no longer the level of the base rate. If mortgage lending criteria were relaxed, repayments would be cheap enough to tempt many more buyers back into the market as the combination of cheaper loans and lower property prices has transformed affordability compared to 12 months ago.
|Lenders are not yet in a mindset or financial position to fund a substantial increase in demand for mortgages.”
1. Tracker mortgages
Borrowers with tracker mortgages will automatically see their rates reduce by 50 basis points in light of the base rate cut.
However, it is feared that many mortgage borrowers will not benefit from February's interest rate cut because of rate floors on tracker deals.
Tracker mortgage literally track the Bank of England’s base rate and borrowers should, therefore, see their monthly payments decrease by 0.5% as a result of this month's cut. However, interest rate floors or ‘collars’ often buried in the terms and conditions of tracker deals mean the rate will never fall below a certain level even if the base rate does.
Although Halifax has pledged not to impose its tracker collars, in January Nationwide said its tracker rates wouldn't fall despite the cut.
Louise Bond, personal finance manager at uSwitch.com, says Nationwide isn't the only lender to impose tracker collars - customers with Skipton and Yorkshire Building Society have already been hit by collar clauses.
2. Fixed-rate mortgages
If you have a fixed-rate mortgage then February's cut won't make any immediate difference to you, as your rate is set in stone for a pre-agreed period of time.
Although some commentators hope the rate cut will enable banks to offer cheaper fixed-rate deals, lenders are still demanding big deposits for the best deals.
3. Standard variable rate (SVR) mortgages
Pre-credit crunch, the advice to homeowners was never to sit on your lender's SVR, but instead remortgage onto a new deal. However, with house prices falling and lenders being increasingly picky about who they lend to, a growing number of people are now stuck on an SVR.
There is a real concern that lenders may not reduce their SVRs - after October's rate cut only around half of lenders passed the full benefit onto SVR customers. After November's, 75% failed to pass it on in full.
Altough Lloyds TSB has promised it will pass on the base rate cut to SVR borrowers in full, other lenders say the high cost of inter-bank borrowing means they can't pass on rate cuts.
The government has repeatedly urged banks to pass on base rate cuts, and it is possible that many will do in order to avoid attracting criticism.
4. New mortgages
It is not yet clear-cut whether new mortgage borrowers will benefit from the cuts. Tecnically, lower interest rates should mean cheaper mortgages, but unless inter-bank lending gets significantly cheaper, mortgage rates will remain where they are.
In January, Woolwich launched its cheapest mortgage ever. The lender, which is owned by Barclays, is offering a fixed-rate mortgage at just 2.29%. This is a full 1.5% cheaper than Woolwich’s previous fixed-rate offering, and is the lowest mortgage on the market for either tracker or fixed-rate deals.
"We are seeing some of the best mortgage rates in a generation," said Andy Gray, head of mortgages at Woolwich. "This is down to increasing competition and the falling cost of lending for the banks.”
David Hollingsworth, mortgage specialist at London & Country, says the launch is good news as it “throws down the gauntlet” to other lenders.
But he warns: “The biggest factor holding back mortgage lending is high LTV requirements. This shows no signs of coming down.”
For example, in January the Royal Bank of Scotland cut its two-year fixed-rate to 3.49%. However, this is only up to 75% LTV. If you only have a 15% deposit, therefore requiring an LTV of 85%, then you would have to pay 5.49%.
“We need to see a narrowing of the difference in rates between LTV bands, and more choice for people with smaller deposits,” explains Hollingsworth.
Louise Bond, from uSwitch.com, adds: "With more and more existing borrowers set to fall into negative equity in 2009, those looking to remortgage will find few, if any, lenders willing to take on this level of risk.
"People coming to the end of their existing deal should seriously consider defaulting to their provider’s SVR as this could be more cost effective than paying hefty fees for what could be a more costly option.”
For savers, interest rate cuts are not good news. If your savings account is variable then it is liable to move down as the base rate goes down.
If your savings account has a fixed rate, then you won’t be directly affected.
However, bear in mind that a climate of falling interest rates makes fixed deals look all the more attractive, and providers are likely to respond by cutting rates on new deals or by pulling existing bonds. This was seen in November, with best-buy AERs falling from over 7% to between 5% and 6%. Rates are now just over 4%, and February's cut is likely to see banks reduce fixed-rates for new savers further.
A lot of variable rate savings accounts come with Bank of England guarantees. These mean that although the rate tracks the base rate, it will not fall below a certain level. Opting for a savings account with this sort of guarantee should offer savers some security during the next year.
In the current climate, many savers are opting for security and ease of access over rate. This is a tough trade-off, and it will depend on your own circumstances and confidence in British banks whether you go for fixed-rate (where any access could see penalised) or variable rate.
Every mortgage lender has a standard variable rate of interest, or SVR, on which it bases all its mortgage deals, including fixed and discounted rate and tracker mortgages. When special deals come to an end, the terms of the deal usually state that the borrower has to pay the lender’s SVR for a period of time or pay redemption penalties. The lender’s SVR is, in turn, based on the Bank of England’s base lending rate decided by the Bank’s Monetary Policy Committee (MPC). Every time the MPC raises its rate, mortgage lenders generally increase their SVR by the same amount but when the MPC lowers its rate, lenders are often slow to pass this on or don’t pass on the full cut to borrowers.
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.
The circumstances in which a property is worth less than the outstanding mortgage debt secured on it. Although it traps householders in their properties, the Council of Mortgage Lenders (CML) says there is no causal link between negative equity and mortgage repayment problems. At the depth of the last housing market recession in 1993, the CML estimated 1.5 million UK households had negative equity but most homeowners sat tight, continued to pay their mortgages and eventually recovered their equity position.
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).
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
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.
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.