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What is the Impact of an Interest Rate Rise?

by James McGregor

We often hear about rising rates of interest but it is not always easy to comprehend what the impact of that will be. Even if we have a basic understanding, whether this will impact us personally and in what way, can be a bit of a mystery. 

What does an Interest Rate Rise Mean

When we hear that interest rates have gone up, it means that the Bank of England have increased their base rate. This is the rate that they lend money to banks. Therefore, if these rates go up and banks pay more to borrow, it means that they will pass this cost on to people who borrow from them. As banks can make more money for lending, they may also be able to pay more interest out on savings as well. The impact of rising interest rates may spread beyond borrowing and saving as well. 

Impact on Loans

When the base rate goes up, the banks will find borrowing is more expensive and will often pass that cost on. If you have a loan with a fixed rate of interest, you will not see a price hike. However, once that fixed rate ends you will find that borrowing will cost you more. You may have paid off the loan so it will not matter, but often fixed rates as part of a mortgage are only for a relatively short term and so will end before the mortgage term ends and you will have to start paying more. Fixed rate deals will increase as well as variable rates and it is likely that most types of borrowing will get more expensive. The dearer types, such as pay day loans and credit cards may not go up if the base rate increases are small, as they are already charging very high amounts and making good profits. But it is likely that cheaper loans, such as personal loans and mortgages will go up. If rates keep going up or increase a lot, then you would expect all borrowing to be impacted and to get more expensive.

Impact on Savings

The impact on savings tends to be more delayed. You will often find that almost as soon as interest rate increases come into effect that loans will go up. However, savings rates tend not to go up so quickly. Often, they will not change with a small rate increase or there will be a delay and possibly an increase that is less than the rate increase. It is wise to look at what is available though, as rates will vary between banks and building societies and some may raise even if the accounts you hold do not. You may also find that rates raise for accounts where you have to tie up your money or where rates are fixed for a period and it could be worth taking a look at these to see whether it will benefit you to move your money. Obviously if you have to keep your money tied up, then you need to be confident that you will not need it in the meantime and that the rate will remain competitive even if base rates rise more. If savings rates do increase, this will encourage more people to save money rather than to spend it, as they will be getting some benefit from keeping it in a bank. This reduction in spending will cause shops to keep their prices low to try to encourage people to buy and this will keep inflation at a lower level (Inflation is measure of price increases).

Impact on Other things

A rise in interest rates will impact lots of other things as well. Lots of companies borrow money and so the cost of their loans will go up and they may pass those costs onto their customers. This means that prices could rise as a result but this could be balanced out by the fact that most people will have less money to spend, due to their loans being more expensive so prices will need to be kept low for them to still buy things. The idea of an interest rate rise is usually to prevent inflation rising too quickly by limiting the number of items people can afford to buy. By increasing their loan costs, they will be less likely to borrow so will have less money to spend and they will need more money to repay the loans they have, also reducing their ability to spend. It can be quite complicated! 

The government will pay more for borrowing and this might mean that they put up taxes or that they will reduce the amount of services that they provide. They may just decide not to expand the services that they are providing. They may just borrow more money anyway, depending on what is happening and what they need to finance. They may not make changes like this and the impact may be quite small on you as an individual but it is worth being aware that changes could come in. 

If you have savings then, the rate rise could benefit you but if you have loans it is unlikely to. However, the more general impact could also effect you even if you do have savings, so you may not benefit as much as you hope. However, if changes are very small, then it may not have a very big impact on you at all. If changes are big, then this could have much more of an impact and it is worth preparing your finances if this is likely to happen by paying off your loans if you can and saving more money. 

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