BoE raises base rate to 3.5%: what this means for your personal finances

Alice Haine, Personal Finance Analyst at Bestinvest, the DIY investing and coaching service, says the widely expected 50 basis point (bps) hike is the ninth increase in a row with the bank rate now at the highest level since October 2008.

“An interest rise less than 10 days before Christmas might feel like a blow for struggling households, but the 50-percentage point hike signals a slower pace of monetary tightening following the 75bps increase last month - the biggest single increase since 1989 – offering a glimmer of hope that the mood is shifting.

“Increasing interest rates when the economy is on the brink of a recession might not be typical behaviour for a central bank, but the Bank of England is intent on taming double-digit inflation and bringing it closer to its target of 2%. Inflation may have passed its peak after dropping to 10.7% in the 12 months to November from a 41-year high of 11.1% in October – with the BoE expecting it to fall rapidly over the first quarter of 2023.

“Higher interest rates will certainly add more pressure on household finances, particularly for borrowers whose finances have already been hammered by the toxic mix of rising prices, falling real incomes, soaring borrowing costs and tax rises next April. But interest rates are widely expected to peak at about 4.5% next year – with rates potentially falling from there as the lender looks to support the economy through the recession.

“For now, with inflation still high at 10.7% and households trying to absorb the sharp rise in interest rates from 0.1% at the start of December last year to 3.5% now – the personal finance misery is far from over, particularly when you consider the damage a contracting economy, rising unemployment and falling property prices can have.

“For younger generations who have only borrowed money during the era of ultra-low rates, an interest rate of 3.5% can seem terrifying, but for those more accustomed to higher interest payments, the expected peak in rates simply takes them back to the bottom end of where rates used to be before the financial crisis of 2008.

“To protect their finances, households should consider reining in expenditure where they can, setting themselves a strict budget for the year ahead, overpaying on their mortgages and topping-up savings to ensure they are ready for the challenges ahead, which in the worst-case scenario could include loss of income due to job loss or employment change.”

“While a 50bps increase in the base rate might feel like another blow for homeowners already contending with higher borrowing costs following more than a decade of ultra-low interest rates – it could be that mortgage rates have already peaked.

“When interest rates go up, borrowing typically becomes more expensive, but with interest rates now expected to peak next year at a lower level than feared only a couple of months ago, mortgage rates, particularly on new products, are not likely to jump significantly as rate increases have already been priced in.

“Homeowners that will see an instant hit to their finances are those on tracker mortgages, which are directly linked to the BoE’s base rate, with today’s increase applied straightaway by their lender.

“Mortgage-holders on a standard variable rate (SVR) - a mortgage that borrowers move onto after finishing an introductory fixed, tracker or discounted deal - could also see their repayments rise if their lender feeds that increase back to customers. Even those locked into a discounted deal - a variable mortgage with a discount on the lender’s SVR for a fixed period - could see an increase if the lender passes it on.

“While homeowners with fixed-rate deals are sitting pretty for now, those whose products expiring next year are facing much higher repayment costs with average repayment hikes of around £250 a month, according to the BoE, when they switch onto their next product.

“The lucky ones are homeowners that locked in longer fixes in 2021, such as a five-year product, before the rate hiking cycle began. They can breathe easy for now but with property prices expected to slide next year as demand eases off, it might be wise to overpay to protect against a downturn which could negatively impact a borrower’s loan-to-value band.

“For first-time buyers, mortgage rates may seem perilously high when you compare them to the past decade when cheap money became the norm, but those who have held mortgages for longer will feel less threatened as they will recall the higher rates typically seen at the start of the century.

“The good news is that average two- and -five-year fixes now sit below the 6% mark*, down from the highs seen in October when the country was still reeling from the impact of former chancellor Kwasi Kwarteng’s disastrous mini budget.

“What all mortgage borrowers must do now is carefully assess the best type of product for their situation. Fixed-rate deals might seem less appealing in the current climate when compared to tracker mortgages, which follow the BoE’s base rate with a set percentage on top, such as 1%. But with interest rates still likely to rise from here, tracker repayments may jump again in the short term. Taking advice from an independent mortgage broker will identify the best path for a borrower’s finances.”

"A higher base rate is never good news for borrowers as it leaves people with less disposable income to spend because more of their money gets gobbled up by interest payments on loans, mortgages, credit cards and overdrafts.

“Anyone with an existing fixed-rate personal or car loan can rest easy as the terms of their loan have already been agreed, but new borrowers will find the cost of credit higher when they comparison shop for a product.

“As Christmas nears – traditionally a high-spending time – consumers that turn to credit to fund the festive celebrations may face an uphill battle to pay it off at the start of 2023. The cost of borrowing on a credit card has jumped to a 16-year high with the average purchase interest rate (APR) on a credit card – the interest rate charged if a balance is not repaid in full including fees - reaching 30.3%*.

“With this increase driven in part by interest rate rises, today’s hike won’t bode well for credit card holders. For those with hefty debts, signing up for a 0% balance transfer credit card that clears the debt with no interest applied for a set period – which can be as long as 34 months – could be the way forward. But lenders can be cautious about issuing these cards, with the more generous 0% periods on the wane and balance transfer fees also edging up.

“For bigger debts, such as large overdrafts or multiple credit cards, it might be wise to consolidate them into a loan so that you know exactly how much you need to repay every month and when the debt will come to an end. Personal loan rates are also edging up, so locking in a good deal now would be wise. Ideally aim to borrow as little as possible over the shortest time possible to secure the lowest rate possible.

“Ultimately, living within your means and not using credit to pay your everyday bills will be key for those that want their finances to survive the next few months, so households that are already finding themselves in deep water should scrutinise their budgets carefully and seek free guidance from a debt counsellor to prevent their situation from worsening.”

“A rate rise is always welcome news for savers, with many already taking advantage of much better deals in the market. Households deposited an additional £6.2 billion with banks and building societies in October - cashing in on top rates of about 2.85% for an easy access account, 4.8% for a fixed rate account and 7% for a regular saver.

“Savers that don’t switch their money to a high-interest account – particularly those with pots languishing in legacy accounts with ultra-low savings rates – are missing out, particularly when you consider the real return on any money in a savings account – even the best ones - is still deeply negative as inflation at 10.7% erodes the purchasing power of that cash.

“However, with the BoE expecting inflation to ease next year, locking in the best fixed rate you can is key as over the longer term when the gap between pay growth and inflation narrows.  Plus, the pace of savings rate rises appears to be easing with some of highest rates withdrawn as interest rate and inflation expectations lower.

“Remember, funneling all of your spare money into savings accounts can also have tax consequences. The combination of higher interest rates and frozen or lower thresholds on income tax means base-rate taxpayers are at now risk of busting their £1,000 personal savings allowance. Those paying the higher 40% tax rate are in more peril as the allowance drops down to £500, while additional tax rate payers receive no concession at all making it imperative to hunt out more tax-efficient options for savings.

“While saving money in an easy-access account makes sense for a rainy day fund, those with longer-term savings goals – more than five years and ideally at least 10 – might want to consider an investment ISA that protects their money from tax. While higher returns from the markets can never be guaranteed, a long-term approach allows a diversified investment portfolio to absorb the highs as well as the lows and potentially deliver inflation-beating growth.”