How will the interest rate cut affect you?
The Bank of England has voted to cut interest rates to 5.25% this month following concerns about the health of the housing market.
Economists in the UK have been calling for lower interest rates to help insulate the slowing economy and housing market. Halifax, the UK's largest mortgage lender, recently warned that lower interest rates were essential to keep the housing market afloat during 2008.
But the cut will not have a direct impact on all mortgage borrowers, and many savers will see their nest eggs attracting less interest as a result. So how will the cut affect you?
Tracker rate mortgage borrowers
The quarter point cut in interest rates should provide relief to borrowers on tracker mortgages. Figures from Moneyfacts suggest that someone on a £100,000 mortgage over 25 years will see their monthly repayment slashed by £14.84. Someone on the same mortgage but only paying the interest will save £20.83 a month.
As well as saving money on their monthly repayments, Moneyfacts says people on tracker rate mortgages - which account for between 25% and 30% of the market - could take advantage of the rate cut by using the savings to make overpayments.
Julia Harris, analyst at Moneyfacts.co.uk, says that if a borrower on a £100,000 mortgage were to re-invest their monthly saving from the interest rate cut back into their mortgage then they could shave 15 months off their mortgage term.
Over 25 years this would save them a total of £4,454.81.
However, not all mortgage lenders allow borrowers to make overpayments. Harris estimates that 84% of mortgages are flexible when it comes to making overpayments so check with your lender before you make plans to do this.
People whose mortgage interest is calculated on an annual basis should avoid making overpayments.
Harris says: “There are 33 mortgage lenders charging interest on an annual basis on some or all of their products. Although you can overpay with these, you will be effectively giving the lender up to a years’ worth of your own money as they will only re-calculate your monthly payments once a year.”
Fixed and SVR borrowers
Halifax, Nationwide, HSBC, Lloyds TSB, Woolwich and RBS have already announced they will reduce their standard variable rates following the cut. But there is no guarantee that all lenders will pass on the interest rate cut to standard variable rates customers. In December, when the Bank of England last reduced interest rates, some lenders failed to reflect this in their standard variable rates.
The Council of Mortgage Lenders says 20% of mortgages are standard variable rate. If this applies to you then it is advisable to think about moving onto a fixed, tracker or discount deal where rates are more competitive. Lenders take advantage of borrower inertia by charging high rates of interest after discount periods expire - but there is nothing stopping you from moving to another product and saving money.
The majority of mortgages in the UK are fixed rate, yet the interest rate cut is unlikely to have much impact. The way mortgage lenders price fixed products is complicated and not reliant on any one factor, so there is no guarantee that today’s cut will result in cheaper fixed rate mortgages.
If you’ve got your savings in a fixed rate account or fixed ISA then the interest rate cut won’t affect you.
But banks and building societies are likely to reduce the rates on their variable accounts as a result of the cut so be prepared. NS&I's has already annouced its Direct ISA will decrease from 6.05% per annum to 5.80%.
Moneyfacts calculates that the impact of the interest rate cut will be £131.25 for someone with savings of £2,500 or £525 for someone with savings of £10,000.
But remember that if your savings account has suddenly got a lot less competitive then you can always move your money to a better deal. With some experts predicting another interest rate cut later this year, fixed rate products are likely to remain popular.
And if you haven’t utilised your £3,000 ISA limit yet then time is running out for you to do so. In the countdown to the new tax year ISA rates tend to get more attractive, so now is a good time to find a deal.
The interest rate cut should be a wake-up call for mortgage borrowers and savers. You can calculate whether you could be better off on a different deal or find the most competitive savings products with our free tools and calculators.
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.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.