Tips for savers and borrowers as interest rates fall

Published:
07 November 2008
Topic:
News,Money,Mortgages,Savings

The Bank of England's Monetary Policy Committee (MPC) isn't known for maverick behaviour. In fact it's been regarded as a fairly predictable beast - increasing or decreasing interest rates on an incremental basis, by a quarter-point here and a quarter-point there. But it's shown a different side to itself recently.

Last month it shocked when it cut interest rates by half of one percent, 24 hours earlier than a decision was expected. And this month, when many economists had been hoping that rates would fall by a whole percentage point but believed another half point cut more likely, the MPC stunned us again when it voted to cut interest rates by 1.5 percentage points. Talk about catching people on the hop.

The Bank of England's decision to reduce Bank rate from 4.5% to 3% took everyone by surprise and what has transpired since, which helps explain the abrupt change in strategy by the Bank, is that the state of the economy is far more perilous than had previously been realised. The International Monetary Fund warned that recession here in the UK is likely to be more severe than in any other industrialised nation. A sobering thought for anyone, not least the people in charge of steering us through these tough times.  Click here to watch our latest video, 'Implications of rate cut'.

What cure is the MPC prescribing?

The MPC will be hoping that the sharp interest rate reduction will encourage consumers to start spending again - if their mortgage rates fall, they'll have more money to spare each month which they can then put back into the economy. But this is far from fail-proof, not least because there is no guarantee that mortgage rates will fall.

Some of the major lenders including Halifax, Abbey, Royal Bank of Scotland, Nationwide and Cheltenham & Gloucester have announced that they will be reducing their standard variable rates (SVRs) by the full 1.5 percentage points. However, 32 lenders still haven't announced changes to their SVR following last month's half-point cut and only 24 lenders reduced their SVR by the full 0.5 points.

In addition, rates on many deals for new borrowers have actually been increasing. Abbey hiked its tracker rates by 0.5 points just two days before the MPC announcement and other major lenders including Halifax, Woolwich, C&G, Alliance & Leicester (A&L) and Northern Rock, have pulled their tracker products, so we'll have to wait and see whether their new rates are higher or lower than the preceding deals.

What's more, while the crisis continues in the mortgage market, savers face the prospect of the value of their money being eroded because inflation is currently higher than the rates on many savings accounts. This begs the question: even if their mortgage costs fall are consumers really going to want to go out spending when the value of their savings is actually depreciating?

We're in strange and uncertain times, so whether you're a borrower, saver or both, we've come up with some tips to help as you digest the implications of the recent interest rate cuts.

Tips for borrowers

Don't assume that your mortgage payments will fall just because you have a variable rate loan

Rates on tracker mortgages must fall because they are tied to the Bank rate, but lenders can do what they want with their standard variable rates (SVRs). Traditionally most lenders do move their SVR in line with changes in Bank rate, but in light of the current conditions there are fears that an increasing number will decide not to.

As we mentioned above a large proportion failed to pass on last month's reduction in full and many fear the same will happen this month. That said, the Government and consumer groups are piling on the pressure for lenders to play fair, and reduce their SVRs by the full 1.5 percentage points.

Be wary of discounts

When interest rates are falling demand for variable rate mortgages unsurprisingly rises as borrowers hope to ride the wave of rate cuts. However, discounted deals are linked to the lender's SVR, not the Bank rate; consequently there is no guarantee that your payments will go down if interest rates fall.

Watch out for trackers with a catch

While tracker mortgages are the most transparent option if you want a variable rate because they are directly linked to Bank rate, some do have a catch: a number of lenders include 'collars' which gives them the mandate not to reduce the rate if Bank rate falls below a certain level.

Normally, borrowers wouldn't be hit by these collars but with Bank rate at its lowest level for more than half a century there is a real possibility that some may not benefit if we see further rate reductions. Halifax and Yorkshire and Skipton Building Societies for example, have collars which kick in at 3% - the level Bank rate is now - while Nationwide's collar takes effect if Bank rate falls below 2.75%.

Don't rule out fixes

With interest rates having fallen two percentage points since September, it may not seem the obvious time to fix your mortgage payments. However, fixed rates shouldn't be ruled out.

Some people will always prefer the security of knowing what their monthly payments will be. Also, remember that interest rates have plummeted recently and Bank rate will bottom out at some point - the argument for fixing will therefore become more compelling over the coming months and an increasing number of borrowers will seek to protect themselves against interest rate rises, when the climate turns.

Remortgage if you're on an SVR

The typical SVR is around 7% - more than double Bank rate. And even though rates on new mortgage products are not as low as Bank rate, there are still savings to be had by remortgaging. Therefore if you are paying your lender's SVR look to switch to another product - if you can.

One of the implications of the mortgage crisis and downturn in the housing market has been that lenders have tightened criteria, and you may find that remortgaging is not an option because you do not have enough equity in your home.  However, if you have more than 25% you will almost certainly be able to save money by remortgaging and even if you have less than that, it's worth looking into as there may be options available.

Five tips for savers

Fix now

With savings rates heading south, savers who are willing to lock their money away for a year or more should act quickly and take advantage of a leading fixed rate deal. Providers have already started pulling fixed rate bonds but there are still a few deals left offering rates in excess of 6%. These won't be around for long however, so you must fix now.

ICICI Bank, for example, has already cut the rate on its Hisave Fixed Rate Account from 7.10% to 6.60%.

Keep an eye on your rate

A number of providers slashed their savings rates by more than 0.5 points following last month's rate cut and we're likely to see the same thing happen again this month as institutions take the opportunity to manipulate their margins.

That said the best rates are likely to remain significantly higher than the 3% Bank rate so check your savings rate, and move to a better-paying account if necessary. Our savings comparison tool will enable you to find a better deal.

Maximise your returns

With inflation running at 5.2%, it's vital to earn as much interest as possible on your savings to avoid the value of your money being eroded.

The leading easy accounts are paying more than 6% although bear in mind that these rates do not reflect the recent interest rate cut, so they're likely to fall in the coming weeks.

Click here to compare rates.

Use your Isa allowance

Savers can place up to £3,600 a year into an individual savings account (Isa) - interest is paid free of tax which gives an immediate boost to your return.  

Click here to compare the leading Isa rates.

Make sure your money is protected

The recent turmoil in the banking sector has focused many people's attention on the security of their money.

The first £50,000 held with a single institution is fully protected under the terms of the Financial Services Compensation Scheme (FSCS).

If you have more than £50,000 in savings you should therefore spread your money around to ensure it is all guaranteed. However, you do need to be careful as some providers such as Halifax, Bank of Scotland, Birmingham Midshires, Intelligent Finance, The AA and Saga are part of the same group and if you have accounts with more than one of them you still only get £50,000 protection. To find out which companies are part of the same institution, read our articles 'Who owns who?' and 'How to keep your savings safe'

Disclaimer: Please note that any rates or deals mentioned in this article were available at the time of writing.

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