What do UK interest rate changes mean for you?

The Bank of England has cut interest rates for the first time since lockdown. We explore the implications this has for your money, from your savings to mortgages, plus what you can do now to prepare for when a change does come.

Between December 2021 and August 2023, the bank’s rate-setting Monetary Policy Committee (MPC) hiked rates 14 times – from an all-time low of 0.1%. Since then, the MPC voted to keep the base rate unchanged.

Until now.

This month’s meeting saw the Bank of England finally react to falling inflation and continued economic growth – by cutting interest rates to 5%.

“It was appropriate to reduce slightly the degree of policy restrictiveness. The impact from past external shocks had abated and there had been some progress in moderating risks of persistence in inflation,” the minutes of the meeting read.

But what does this change mean for you? In this article, we cover:

• How does changing interest rates help inflation? 
• How will my mortgage be affected by rising interest rates?
• What does the interest rate rise means for savings?
• What does an interest rate rise means for pensions?
• How do interest rates impact the UK housing market?

Read more: Will UK mortgage rates go down in 2024?

How does changing interest rates help combat inflation?

Raising interest rates is one tool that central banks can use to try to bring inflation down. If it is more expensive to borrow money – for banks, people and businesses – we are likely to spend less and save more. Lower demand for goods and services should limit price rises.

Higher rates also makes it harder to expand or start a business, and could possibly see existing organisations forced to make cutbacks or even go bust. Job losses mean more people looking for work, resulting in less pressure on companies to raise wages of current workers or new hires.

Lower wage rises also means we have less money to spend on goods and so there is more pressure on companies to keep prices lower.

The two problems with that theory are that, firstly, it takes as long a 18 months for an interest rate rise to filter through to the economy.

Secondly, none of this helps prevent price rises driven by international energy price rises or supply shortages caused by Covid, adverse weather hurting crop yields, tankers getting stuck in the Suez Canal or attacks on oil tankers in the Red Sea.

That said, doing nothing at all while inflation remains high risks turning externally driven price rises into wage rises – which could keep prices rises long after the external factors have abated.

Find out more about how interest rates affect inflation here.

How will my mortgage be affected by lower interest rates?

According to the government’s English Housing Survey around a third of households have a mortgage. How you will be affected depends on the type of home loan that you have.

If you’re on a tracker or variable mortgage, your payments go down almost immediately in response to a base rate hike. The reverse is true when rates rise.

That’s because these products generally move in line with the Bank of England, so when it rises, your payments rise, and when it falls, your bills fall, too.

With 639,000 properties on tracker mortgages and 773,000 on standard variable rates, one in four mortgage customers saw their mortgage payments rise every six weeks from December 2021 until August 2023.

After a base rate change, your lender will write to you and let you know how you will be affected.

Your mortgage contract should explain how quickly these changes should take effect.

How much will my variable mortgage go down by?

Last August’s increase in the Bank rate from 5% to 5.25% meant that those on a standard variable rate mortgage faced paying about £33 more a month if borrowing £200,000 over 25 years.

They can expect this to be reversed after this August’s fall in rates.

Wondering if you should get a two-year or five-year fixed rate mortgage?

I’m on a fixed mortgage, what does the base rate cut mean for me?

If you have a fixed deal, you will be unaffected for now. However, when your deal ends, you will likely find yourself paying significantly more than you were in previous years, despite the cut.

There are six million households on fixed-rate mortgages in the UK. Around 800,000 of those deals will end this year, as the two-year anniversary of the stamp duty approaches – leading to serious increases in homeowners’ bills.

But rates two years ago were still significantly lower than they are now – so unless the Bank acts to cut rates again before your deal expires, you can expect to pay more.

See our article on what’s happening to mortgage rates for more.

Should I remortgage now?

If your mortgage is approaching expiry and you want to fix, you can do so with a number of lenders up to six months in advance. All major lenders allow this, including NatWest, Nationwide and Barclays. This starts from the date of offer issue (after underwriting).

The better news is you can lock in a rate today, and – if interest rates fall again between now and when you’re due to switch – change to a new deal later on.

Doing a product transfer with the same lender, rather than a full remortgage with a new lender, can save some time, and often doesn’t come with fees.

Another difference is that you generally avoid a new affordability assessment by sticking with the same lender. While this might help streamline the process, you need to make sure you can afford the new rate offered.

But you can’t be sure you’re getting the best interest rate on the market – so shop around. See our guide on remortgaging.

If you are wondering whether to opt for a two of five year fixed rate mortgage, we weigh up the pros and cons of each.

Alternatively, you could consider a tracker mortgage. These track the base rate plus around 1 percentage point. Some homeowners are considering trackers while they wait for rates to fall further.

Read more: Help! Our cheap five year fixed-rate mortgage is coming to an end

Some tips to consider for remortgaging:

• Consult a broker: rates are changing quickly right now. Often, mortgage brokers will get a heads-up when a deal is about to be pulled, so it’s worth speaking to one.
• Charges and fees: watch out for early repayment charges or exit penalties if you are considering switching before your current deal ends. Other costs include arrangement fees, valuation charges and the cost of a solicitor. It could still work out cheaper in the long run for you to pay the fees and charges, but make sure you crunch the numbers.
• Use a mortgage calculator: choosing the deal with the lowest interest rate can save you a lot of money in repayments. Use this mortgage calculator and remember to factor in any fees and charges.
• Benchmark the best deal for you: Shop around for the best deal on the market. We have a free mortgage comparison tool that can help you benchmark the best deals for you.

How interest rate rises affect savings

In theory, lower base rates mean lower interest on savings accounts. But in the past many banks have been slow to pass on rate rises to savers, and cut rates before the Bank of England too.

Savings rates rose substantially from December 2021, and you can now find accounts paying much higher interest than the current inflation rate. This means you can gain value on your savings in real terms.

We have a rundown of the top interest rates on savings accounts here.

Remember, you have a personal savings allowance on non-ISA accounts so it might be worth looking at cash ISAs.

Investing can generate higher returns over long periods, but this comes with risk.

Read more: How to invest to beat inflation

What about the effect of the base rate on loans, debt and credit cards?

The rates on personal loans and credit cards rose last year in response to the moves from the Bank of England. They should fall in response to cuts in the base rate, but this might take some time.

If you have a personal loan already, most are taken on fixed rates so you should not see a change in your monthly payments in response to a base rate rise.

If you have a credit card, rates are variable but not typically explicitly linked to the base rate. This means they won’t necessarily go down immediately.

But if you’re taking out a new loan, credit card or overdraft after a rate increase, it’s likely that you will be able to find a lower rate soon than a few months ago.

Are pensioners affected by high base rates?

If you have a private pension and want to buy an annuity to provide an income in retirement you could lose out as a result of lower base rates.

Annuity providers invest in government bonds. These bonds are expensive when interest rates are low as other investors want to hold them.

When rates rise, these investors are inclined to sell the bonds, which typically makes them cheaper.

As a result, annuity providers had been able to offer better returns while rates were high

The state pension is not linked to the base rate and is therefore unaffected.

People with defined benefit pensions – where the payout is based on your salary – might see changes too. That’s because in times where rates are higher, it can be cheaper to increase your contribution levels.

Read more: Is pausing your workplace pension ever a good idea?

How do interest rates impact the UK housing market?

Employment rates, how much people are earning, the cost of borrowing, the number of properties on the market and the willingness to lend are the main factors that affect house prices.

Generally, when the economy is doing well, people are in work, job security is stable and wages are higher. When interest rates are low, people are also able to borrow more money to fund a purchase. Providing banks are willing to lend, more people will buy.

Right now, we’re in a market with much higher mortgage rates compared to the record lows seen in December 2021. The high cost of living has also chipped away at the amount people can afford to borrow and how much they are able to save for a deposit.

The interest rate has a key part to play in this:

• The lower interest rates are, the lower the cost of borrowing. This means more people will be able to take out a larger mortgage, fuelling more buyers
• The higher the rates, the more expensive it will be to borrow and therefore fewer people will be able to afford to buy. It also means there are likely to be more repossessions – adding more properties to the market

It’s important to note that people who have paid off their mortgage, or are buying a home with cash, will not be affected by higher mortgage rates.

For tenants, figures show the cost of living is fuelling rent increases, especially in major cities. The ONS has said rent rises are at record highs – reducing the ability of renters to save for a deposit.

Read more: How to rent guide: 13 tips for finding a home

How is the Bank of England base rate set?

The Bank’s Monetary Policy Committee (MPC) meets to discuss and set UK interest rates eight times a year. This happens roughly once every six weeks, with announcements made on a Thursday.

In these meetings, the nine members of the MPC, including governor Andrew Bailey, vote on whether rates should change based on what’s most likely to see inflation be remain at 2% in the medium term.

When is the next interest rate decision? 

The Bank of England will next meet to vote on Thursday 19 September 2024.

Read more: When will interest rates go down again?