How To Prepare For An Interest Rate Rise

Red Balloons Showing Interest Rates

If you follow the movement of the economy and interest rates… you likely have whiplash right now. Or at least a pounding headache! While it is tempting to turn off the news, fold the newspaper or scroll by on your feed, the trajectory of interest rates has a great deal to do with your life. Specifically, it influences the cost of borrowing money. We are not talking about a few pence here and there; we are talking about potentially thousands of pounds – and this can impact whether or not you can afford to purchase a home.

What does an interest rate hike mean for you? And how can you prepare?

In this guide, we will tackle these questions and provide you with clear, helpful information that will help you position yourself for a stronger, more secure and financially sound future.

Here, you will learn about:

  • Interest rates and who sets them
  • Current interest rates – and what’s next
  • The role of interest rates in fighting inflation
  • Saving
  • How to prepare for an interest rate rise
  • Likely recession coming

We will also provide useful tips that allow you to start making a plan that will help you keep your finances in order even as the world feels anything but orderly.

Up… Up… and Up

First, let’s talk about interest rates. Perhaps not the most interesting topic under the sun, but it is important to understand the lay of the land, so to speak. In the UK, interest rates are set by the Bank of England’s Monetary Policy Committee. Also known as the ‘bank rate,’ it is the rate at which banks borrow from the BoE. So, when interest rates rise, it is because the MPC has determined that is the best course of action (we’ll delve into why in a moment) and thus is increasing the base rate.

Banks are not required to follow the MPC’s interest rate decisions. Typically, though, they do follow the lead of the BoE in this matter. As recently as 2020, interest rates were at levels well below 1%. In March of that year, for example, we saw rates of just 0.25%.

In the lead-up to the ‘Great Recession,’ interest rates climbed to 5.7% (July 2007). Since, though, they have fallen. Until now.

While we have seen a fairly flat line in terms of interest rates for the past several years, it began ticking upwards. Currently, it stands at 1.75%.

Is this a big deal? Well, think about it like this: in March of 2020, you could borrow £250,000 for a fixed loan term of 30 years at a rate of 0.25%, and it would make your total loan cost £259,518. Total interest would be £9,518. Fast forward to today with our 1.75% interest rate. Your total loan amount for £250,000 is now £321,519, with total interest at £71,519.

You are borrowing the same amount of money but paying £62,000 more for the privilege. At the same time, the cost of purchasing a home has increased dramatically, so you will not be able to get as much ‘house’ for your money.

What about people who already have a mortgage? If you have a fixed rate mortgage, you won’t see any changes. Your interest rate is locked in, so to speak. However, if you want to remortgage or refinance, you will find it is more costly to do so. About three-quarters of UK households with a mortgage have a fixed rate.

If you have a variable rate tracker mortgage (i.e. a loan that follows the BoE’s base rates. So if there is a decrease, you will see it reflected on your monthly payment. Conversely, if there is a rate increase, you will also see a jump on your next payment), you will likely see an immediate change.

With a standard variable rate mortgage, you will also see an increase that coincides with interest rate rises. Your lender will determine how much (check your mortgage offer document to find out more).

It is expected that the average mortgage payment will rise by about £50 per month. Adding insult to injury, the average household fuel bill will climb to £300 a month while the average food bill will increase by £454 a year. While not much to some, it is a lot to many. This figure can mean the difference between being, and feeling, secure and not knowing how you will manage. Especially as there seems to be no relief on the horizon.

In fact, the MPC states that ‘Returning inflation to its 2% target remains our absolute priority, no ifs, no buts.’ To achieve this goal they will be ‘particularly alert to indications of more persistent price pressures, and will if necessary act forcefully in response.’

So that’s why this matters to you. This is why it is important to educate yourself around how to prepare for an interest rate rise.

What’s Next?

Experts predict that the BoE will increase interest rates to 3% or 4% in the near term. According to Andrew Sentance, senior advisor with Cambridge Econometrics and former MPC member, ‘The Bank of England has been quite slow in responding and is clearly behind the curve in trying to get on top of this surge in inflation. They don’t have an easy job at the moment, but they do have tools at their disposal, particularly interest rates, and they’ve been rather slow in moving them upwards.’

The latest increase is the largest in 27 years, and there is no end in sight. Now we mentioned the ‘i’ word – inflation. What does this have to do with interest rates?

As you are likely all too aware, prices for virtually everything, from fuel to groceries to homes, have skyrocketed post-pandemic. Petrol has increased 45%, milk 40%, flour 31% and tea bags 14%, for example. A trip to the market costs much more than it did even a year ago. The UK’s inflation rate has hit 10.1%, the highest level in 40 years. This is only the fourth time in the past seven decades that inflation has broken the 10% mark. Experts predict that it will hit 13.3% by fall and remain high throughout 2023.

Why now? As COVID restrictions eased and lifted, consumers boosted spending. We could finally go out to eat, shop at real stores, travel…. At the same time, supply chain issues have created shortages; with more demand and less supply, if you will, prices are pushed upwards.

The MPC said in a statement that the interest rate rise, ‘largely reflects a near doubling in wholesale gas prices since May, owing to Russia’s restriction of gas supplies to Europe and the risk of further curbs. As this feeds through to retail energy prices, it will exacerbate the fall in real incomes for UK households and further increase UK CPI inflation in the near term.’

Tools to Curb Inflation

One of the tools that Sentance mentioned to curb inflation is interest rates. Raising them makes it more expensive to borrow money. In theory, it’s meant to encourage people to spend (and borrow) less. At the same time, the BoE cannot wantonly raise rates because it cannot slow the economy too much. It is a tough line to hold.

Let’s go back to our £250,000 example. To borrow this at a 4% interest rate would bring your total loan cost to £429,673, with total interest at £179,674.

Bank of England Governor Andrew Bailey said of the MPC’s decision to raise interest rates, “I recognise the significant impact this will have, and how difficult the cost-of-living challenge will continue to be for many people in the United Kingdom. Inflation hits the least well-off hardest, but if we don’t act to prevent inflation becoming persistent, the consequences later will be worse, and that will require larger increases in interest rates.

The UK is not the only place where inflation is running rampant and interest rates are being raised to try to combat it. The same story, or similar, is playing out in the US, India, Canada, Australia, Switzerland… and countries around the globe.

What About Saving?

Now, it should follow that if interest rates go up, you will earn more when saving. Logical – but this is not how it is playing out in the real world. In August 2022, interest rates rose 0.5%. It was the sixth consecutive increase. However, according to recent research, UK banks and building societies passed on the 0.5% increase to only two out of 233 easy access savings accounts. Only 11.2% of easy access accounts saw an increase (even if not the full 0.5%).

Rachel Springall with financial data firm Moneyfacts says, ‘As we have seen time and time again, there is no guarantee savings providers will boost their rates because of a Bank of England rate rise and, even if they do, it could take a few months to trickle through to customers.’

This is not meant to discourage you from saving. Far from! It is more important now than ever to create an emergency fund and stay vigilant about putting money away. Our goal is to provide information so you can make decisions that are right for your financial situation.

How to Prepare for an Interest Rate Rise

Now to the meat of the matter: how do you prepare for an interest rate rise? Some helpful tips:

Develop a Financial Plan

You know the current state of affairs when it comes to interest rates; you know what is likely to happen next. Now plan for it. Experts forecast small increases (say 0.25%) that will be steady. This can add up to a significant impact.

Start with:

Getting a Clear Picture of Your Finances

Where are you now? Knowing this will help you take directed action for what’s coming next. Start with a deep look at your personal finances. This can be uncomfortable and difficult. Do it anyway. Look at how much you have in savings and how much debt you are carrying. Access statements from accounts that have liquid cash (i.e. that you can withdraw without facing penalties), such as savings accounts, money market accounts and no-penalty CDs.

List out your current debts, including the balance and interest rate charged. How much are you spending on these debts each month? How much income do you have coming in?

Now the hard part: look at your monthly bills versus income. Work to identify areas that you can take care of now, such as paying off smaller debts or cutting expenses. For example, if you’re spending £20 for a meal at a restaurant – and doing so a few times a week – eat at home. While pricier than we’ve seen in a while, buying groceries is still typically less expensive than eating out. Can you cut extras, like streaming services or output on clothing?

It is important to make a concerted effort to live within your means or, even better, below your means.

Determining What Mortgage You Are On

As we mentioned earlier, the impact of interest rate rises will depend largely on the type of mortgage you are on. Check immediately. Ideally, your loan is a fixed rate product, and changes will not affect you (unless or until your deal ends and/or you need to refinance). Variable rates are trickier, and you may have to adapt to a larger amount monthly.

Check your loan paperwork or speak with your lender.

If your deal is coming to an end (or even if it is not), it’s worth shopping around to find financing with better rates.

Determine How an Interest Rate Will Impact You

What’s the bottom line here? How much will your finances be affected by a rate increase? An easy way to find out is to use a basic mortgage calculator. If you are facing a situation in which it will cost more to borrow money, figure out how much. Can you afford this? If you are thinking of purchasing a home, is now the time? Work with a financial advisor to answer these important questions.

What Can You Afford?

Again, if you are going to see a rise, determine if you can afford it. This starts with creating a budget. Are there areas in which you can cut back? Are there ways you can increase your savings? The best time to start saving (and planning) is now. If you have not already, commit to building up a buffer in case interest rates impact your life.

It is a good idea to seek assistance and guidance from a debt advisor. And no, you don’t have to be in debt! These professionals will help you examine or build your budget, as well as assess income versus expenditures in order to prevent financial hardships before they have a chance to take root.

You do not have to go into debt to work with a debt advisor either. Find a free service near you.

Shore Up Your Credit Score

Like savings, the best time to start working on your credit score is now. The better your score, the better the terms and rates you can get from lenders. You can access a free credit report; review it. Are there any erroneous entries? Are there smaller debts that you can clear up with relative ease? Every step you take towards a better score is worth it.

Know Good Debt versus Bad Debt

Some debt is considered ‘good.’ For example, a mortgage is a good debt. It typically carries a low interest rate compared with, say, a credit card. It also helps strengthen your credit when you make payments on time.

Now bad debt is that which carries high interest rates. Your credit card is a prime example (more on credit cards specifically in a moment). Make efforts to pay off this bad debt.

In some cases, it is better to delay paying off low-cost debt in economic conditions such as those we are experiencing currently. Instead, you might consider using those funds for other purposes, primarily saving or investing.

Overpay On Your Mortgage

This can be a hard one, but make every effort to pay beyond the minimum amount each month. But remember: it’s not going to get any cheaper. It often takes a while before interest rate increases hit you in the pocketbook, so pay extra now. Ask your lender about limits on how much you can overpay and any fees associated with an early pay-off.

Save, Save, Save

Yes, we did mention that banks don’t always pass on interest rate hikes. That should not stop you from putting money aside. You need a ‘what if’ fund at the very least. Mike Schenk, deputy chief advocacy officer with the Credit Union National Association in the US, says, ‘Building a rainy day fund is really important, even if the interest rate you’re earning on those funds is lower than the inflation rate. Put a little bit into a savings account over time, and before you know it, you’ll have a chunk of savings that can give you a better night’s sleep at the very least.’

Identify Ways to Increase Income

Another ‘easier said than done’ item, but nonetheless an important one. While we cannot control what happens with the economy and interest rates, we can control how we respond. One of the biggest investments you make is not in a home but in yourself. Now may be the time to get more training or education to develop your skills. This can help you increase your earning power.

You may also look at assets that you can access without cost. For example, do you have a CD or investment you can tap into? Be wary of cashing in retirement accounts; not only will you pay onerous fees, you will put your future financial condition in jeopardy. This is a last resort.

Don’t Forget About Your Credit Cards

If you have a credit card or two, remember that increased rate rises also affect your payments. Improving your credit score can help you achieve better rates, so continue working on that. Also, communicate with the issuer of the card. They may reduce your interest rate, which is completely within their purview. If they do not decrease your interest rate, they risk you defaulting altogether and, at best, recouping a fraction of the debt via a collections agency. They also risk losing you as a customer.

Speaking of which: If the credit card issuer does not agree to reduce your interest rate, look for a card that offers balance transfers and more attractive rates. Shop around. There are more options than ever. Just be cautious about getting a new card with a higher line of credit – and then spending more than you can afford. You’ll wind up in an even less favourable set of circumstances.

It is essential that you work to pay down or pay off your credit card. You can explore a few different options and work out which is best for you.

For example:

  • The Debt Snowball Method. Here, you clear your smallest debt first. Then you take that amount and apply it to the next smallest. Once you clear that, you apply those payment amounts and roll them into the payment for the next on the list. Quickly it begins to ‘snowball,’ and you gain significant momentum in paying off debt.
  • The Debt Avalanche Method. With this approach, you work on paying down the debt that has the highest interest rate.

These approaches, of course, also work with debt other than credit cards. Take a comprehensive and honest look at your current state of affairs, as mentioned, and go from there. The worst thing you can do is… nothing. You cannot ignore debt. It does not just disappear.

Think About Buying a House Sooner Rather Than Later

This may sound like counterintuitive advice. But as interest rates climb, you will be able to afford less and less house. We expect interest rates to rise steadily. While some do not think we’ll hit 4%, we could well be looking at 3%. If you are in the market for a home, and have other financial details ironed out, now may be the time to buy.

This also applies to larger purchases like vehicles. If all is stable in your financial condition, maybe the sooner rather than later approach works for you.

As always, it never hurts to consult with a financial advisor so you can really determine if this is the best move for you.

Recession on the Horizon?

The BoE’s MPC forecasts that the UK will enter into recession at the tail end of 2022. They expect it to last five quarters, coinciding with decreases in real household incomes. In their monetary policy report, the MPC says, ‘Growth thereafter is very weak by historic standards. The contraction in output and weak growth outlook beyond that predominantly reflect the significant adverse impact of the sharp rises in global energy and tradable goods prices on UK household real incomes.’

Not the news we would hope for – but it need not be dire when it comes to your financial situation. It is important to hope for the best and prepare for reality! When it comes to preparing for a recession, many of the steps we have discussed apply. From saving as much as possible to cutting extraneous expenses to opting for fixed rate loan instruments, shoring up your financial standing is critical.

One difference though is that it is generally unwise to take on new debt as the prospect of recession looms. This includes homes, cars and larger purchases. It’s a balancing act, because interest rates will rise and we see no imminent slowdown. Speak with a financial advisor to chart the best course for you.

You also want to avoid:

  • Acting as a co-signer on a loan
  • Making high risk investments
  • Getting a variable rate mortgage or loan
  • Making career changes that are impulsive or otherwise put your financial status at risk
  • Overspending (where can you cut back?)

There is no doubt that these are trying times and, as Andrew Bailey says, interest rate rises and recession affect the least well-off in the most profound ways. No matter where you fall on the spectrum in terms of income, savings and debt, you can take action now to mitigate the impacts of economic downturns.

It is tempting to let a feeling of overwhelm or powerlessness take over. After all, you cannot control what you pay for petrol or how much a liter of milk is at the store. But you can control how you respond, the steps you take to save money, the decisions you make in terms of purchases and investments. You can access financial and debt advice. You can work with professionals (at little to no cost) to strengthen your financial situation.

Are You Ready?

As we have discussed how to prepare for an interest rate rise, how do you feel about your current financial situation? Do you feel well prepared to weather the storm, as it were? Or do you feel as if you need some assistance? We all have work we can do to improve our circumstances, and there’s no time like the present.

As interest rates rise and inflation runs rampant, it often feels as if there is very little we can do. This type of thinking will not serve you well as you try to achieve your goals. Instead, adopt a mindset that with action and effort, you can greatly improve your situation and prepare for the future.

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