More pain for mortgage holders and those with debt as interest rates hit 14-year high

AJ Bell press comment - 2 February 2023Danni Hewson, AJ Bell financial analyst, comments on the latest Bank of England interest rate rise:

"Today's decision to hike the Base Rate to 4% was exactly what markets were expecting - foul tasting medicine, but a dose seen as necessary by the majority of members of the MPC. The tenth jump in a row will add to the pain being felt by many households, particularly those who've turned to credit as a solution to the cost-of-living crisis, or those facing the prospect of re-mortgaging over the coming year.

"Twelve months ago, when the bank raised rates to 0.5%, its prediction that inflation would peak at 7.25% was met with a degree of surprise, as it was far higher than had previously been expected and came in way above the bank's 2% target. What came next in the shape of Russia's invasion of Ukraine, a summer of political malcontent, a mini-Budget with disastrous consequences and a winter of strike action that's spread into the new year could not have been imagined.

"Inflation has begun its painfully slow decline but core expenses like food are still running uncomfortably hot for many families who are choosing to eat goods way past their use by dates or go without meals entirely. The government says inflation is the most damaging tax on our standard of living, but it's far from the only additional pressure our budgets will face this year.

"And with the bank now expecting inflation to fall to around 4% towards the end of the year, there are still a lot of difficult months ahead.

"There are glimmers of silver lurking in the lining of today's storm clouds. The bank still expects the UK will experience a recession, but it now believes it won't be as deep or as long as previously feared. And though interest rates haven't peaked quite yet they appear to be almost at the top of this cycle, with just another half a percentage point hike for us to budget in.

"But anyone hoping for a swift return to ultra-low interest rates needs to prepare themselves for disappointment. The bank currently expects interest rates will fall again, but not by much in the short term. It's currently anticipating the base rate will eventually begin to fall and will stand at around 3.25% in three years' time."

What does the rate rise mean for…

• Homeowners:

"According to ONS figures more than 1.4 million people have a fixed rate mortgage which will be up for renewal over the next year. Whilst rates have fallen since the mini-Budget threw a grenade into the works, those people will find that whatever choice they make their monthly payments will be substantially higher.

"The question many homeowners have been asking is whether they should hold off re-fixing until rates come down and instead go for a variable rate or a tracker mortgage. Every situation will be different, so the best course of action will be to talk to a broker to get the right advice for you.

"What is certain is that the 1.6 million people on a tracker or variable rate will see their costs go up almost immediately. For someone with £250,000 of borrowing, a 0.5% rise means an extra £72 a month in costs. At £400,0000 of borrowing that rises to an extra £115 a month or £1,380* a year.

"And it's important to remember that today's increase is the tenth in a row and for many mortgage holders the financial shock has been or will be acute. With thousands of pounds a year being added onto a typical mortgage, there will be some who are finding their home has become unaffordable.

"There are options people can consider, like extending the term of the mortgage, moving to interest-only or using an offset mortgage. It is important to remember that whilst these may cost more in the long term, they could provide a lifeline during the current cost-of-living crisis."

• Savers:

"Savers are expected to get another boost from today's rate rise, but only if they seek out the best rates instead of leaving their cash languishing in their current account or in old savings accounts that haven't moved with the times.

"This time last year the top easy access account was paying just 0.71%. Today it's 3%**, and the top two-year fixed rate account has gone from 1.62% to a healthy 4.45%. With markets predicting at least one more rate hike cycle, savers might want to hold fire on locking in their money assuming the full benefit of the hike will be passed on to savers.

"But it seems the savings war has lost a lot of its heat and even with careful money management the rates on offer for cash savings are still eclipsed by inflation currently running at 10.5%."

• Those in debt:

"Whilst the savings war might have fizzled out, we can be sure that banks will be quick to pass on this rate rise to their customers with credit cards or personal loans.

"With prices rising just about everywhere, more and more people have been popping things on their credit card and this Christmas is expected to have made the nation's debt pile even higher.

"Personal loan costs have soared with the average rate rising to a five-year high, up to almost 8%*** in November. In general, those people who are being pushed into borrowing are finding they're being hit with higher costs, and that makes keeping up with repayments more difficult.

"It won't be an option for everyone but if you have credit card borrowing it's worth seeing if you can transfer to a 0% balance transfer deal or if you are eligible for an interest-free overdraft.

"Never ignore problem debt and if you feel you're caught in a debt spiral, being dragged deeper and deeper into the mire, do seek help and don't just ignore the problem because it will just keep getting bigger."

* Based on current mortgage rate of 4.5%, on a repayment with a 25-year term.

** Based on data from Moneyfacts.co.uk - correct as of 2 February 2023.

*** Based on Bank of England data:Money and Credit - November 2022 | Bank of England