Interest rates shape our economy because it decides whether we save and borrow. They seem often to make headlines, and yet the impact of the interest rate on the economy can be easier to get a handle on than you’d think. Let’s go into what interest rates are and how they’re important.
What Are Interest Rates?
At its most basic, an interest rate is the price paid to borrow money. To illustrate this, consider borrowing £10 at a 10% interest rate: you would pay back £11—£10 for the principal and £1 in interest. Banks apply much more complex formulas to work out interest, but this is the principle.
The Role of the Bank of England
The Bank of England sets what is called the “base interest rate.” This rate dictates to which cost banks pay central banks to borrow money, plus acts as a benchmark for what a consumer will experience regarding their interest rates. It sets this rate every six weeks for review and adjustment to dictate loan costs and the rate on savings throughout the country.
Effect of Increasing Interest Rates
With higher base rates, borrowing becomes costlier, and loan overextensions are discouraged. Borrowing becomes cheaper at a lower rate, and this encourages spending and investment. After the shock of the economy by the Covid-19 pandemic, the interest rates had surged more than 5% and tapered out. It is expected to continue the trend up to 2025.
Interest Rate Impact on Mortgages
Interest rates are particularly relevant to homeowners with mortgages. As mortgages represent long-term lending aimed at securing property rights, changes in the Bank of England’s base rate affect them. Such alterations differ from one kind of mortgage to another :
Fixed rate types of mortgages: The payout will be the same afterwards after a fixed period. For instance, two years or five years, regardless of whether the market interest rates have shifted. They will rise once the period is over and if their base rate has advanced since fresh rates will prevail.
Tracker Types of Mortgages: Extended by the action of the Bank of England’s base rate. Anything that varies the base rate will also affect the individual’s monthly mortgage payments possibly going up or down.
Why Does the Bank Change Interest Rates?
The Bank of England primarily changes interest rates to manage inflation–the rate at which prices of goods and services are moving. If the bank raises its interest rate, borrowing becomes less attractive to consumers and saving more appealing. The effect of interest rates will reduce spending to stabilize prices and bring it within an acceptable limit of the rate of inflation.
Blessings for Savers
Higher interest rates benefit savers by increasing the return on deposits. In other words, the more you deposit in a bank, the more you lend it to the institution, therefore higher rates mean you gain more from your savings.
