We discuss the practical implications of the fluctuating base rate on your mortgage.
What is the Bank of England base rate?
The Bank of England base rate is the UK's official rate of interest. It acts as the benchmark lending rate, which major banks and building societies will incorporate into their own interest calculations. One of the Bank of England's core purposes is to monitor and maintain the stability of the economy, and it is through establishing a base rate that it aims to control inflation and facilitate the recovery of today's ailing economy.
The rate of lending set by mortgage lenders also depends on the fluctuating LIBOR (London Inter-Bank Offered Rate). This is the rate at which members of the London wholesale money market lend money to one another; a global benchmark for the cost of borrowing which is regularly re-calculated by the British Bankers’ Association. Lately it has increasingly become a point of reference for a number of international money markets, helping to inform mortgage lenders' decisions on the interest rate they will offer their borrowers.
Although it might be expected that a cut in Bank of England base rates will mean immediate good news for borrowers, the setting of the base rate should be seen not as a direct instruction to lenders but rather a guideline suggestion. Banks do not have to implement this new rate in their mortgage deals and often will not; the base rate is just one of the variables that lenders will take into consideration when setting rates.
Part of the reasoning behind lenders' reluctance to pass on the base rate is that it is too risky, in the current economic instability, not to retain some of the margin between their rates and the Bank of England's as profit for themselves. Also, the very nature of lending presently poses a risk because of the nationwide financial strain; lenders have lost confidence in the certainty of a return on their money. Furthermore, the amount that is paid out by banks in savings interest rates needs to be balanced by the return they get on any lending.
How will the new rates affect my mortgage?
The lowering of the base rate can have an effect on your mortgage in several different ways. It is hoped by the Monetary Policy Committee, who are behind the cut in base rate, that their recent decision will encourage mortgage lenders to offer cheaper interest rates and to implement a more generous approach to lending, thereby helping to boost the economy. However, whether or not your lender will pass on the new base rate will depend on a number of factors, including what kind of mortgage you have.
Due to the volatile nature of interest rates and how they are interpreted by respective lenders, you may see little to no change in the rate on your mortgage after this latest cut. A lot depends on what kind of mortgage you currently have. While movements in the base rate used to have a more definite impact on lending rates, now mortgage providers are relying more heavily on other considerations when making a decision on their own rates.
Fixed-Rate Mortgages
Fixed-rate mortgages may seem, for those seeking stability in an unstable financial environment, a very worthwhile option. Because they are fixed at an initial rate, regardless of ups and downs in the LIBOR and base rate, you’ll experience no effect from the latest cuts if you have this kind of mortgage during your fixed deal.
However most fixed-rate mortgages, while starting you out at an initial attractive rate, will automatically revert your payments to the lender’s standard variable rate (SVR) after a number of years. While you’re unlikely to be able to move your fixed-rate mortgage mid-term because of the early repayment fees many lenders impose, it is advisable that once your fixed-rate deal comes to an end you should avoid sitting on your current lender’s SVR and shop around for a better rate.
Conversely, if you decide to stay with your current mortgage provider at the end of your fixed-rate term, you should be able to look into renegotiating your deal with your lender. Unless there are any tie-in clauses, this is sometimes a preferable option to switching your mortgage elsewhere because it can cut down on fees for arrangement, application, and so on.
Tracker Mortgages
If you are a tracker mortgage holder the recent plummet in the Bank of England base rate will almost certainly have had a positive effect on your mortgage, decreasing the amount of interest you will be paying back. As tracker mortgages oscillate in tandem with the ups and downs of the market, your interest rates should have fallen alongside those set by the Bank of England.
However, it should be noted that many mortgage lenders now impose a restriction on how far their interest rates can fall, even on their tracker mortgages. Called ‘capping’ or ‘collaring’, these measures enforce a low-level limit on interest rates so that they cannot fall below a certain amount – meaning that, if your mortgage abides by one of these capped rates, your mortgage will not be affected by any movement in the base rate.
Standard Variable Rate (SVR) Mortgages
SVR mortgages are those which you pay interest on at the lender’s standard rate, though this may vary throughout the time it takes to make repayments. Mortgage-holders on a standard variable rate will on the most part be influenced by the cuts (though not as directly as tracker mortgages), but it will be largely down to the decision of the lender to what extent the cuts are passed on to their borrowers.
It's worth looking closely at your current provider's rate if you hold one of these mortgages, and researching the other options available if this one is not competitive.
This is true of all mortgage alternatives in view of the current market fluctuations. Make sure that you do your research if you are taking a mortgage out for the first time; but equally if you have held the same mortgage for years. You may find that the best option for you is to enjoy the security offered by a fixed rate mortgage; however you may also find that other options can offer you a better deal that will save you money when you most need it.
Offset Mortgages
Offset or current account mortgages are those which enable you to gather all your savings, current account, credit card balance and any personal loans – along with your mortgage – into one place. This means that you pay the same interest rate across the board, which can be a convenient way to consolidate your finances, as well as balancing the decreasing returns available on savings accounts.
Although offset mortgages offer flexibility, their rates are still influenced by the flux of the Bank of England base rate. Like tracker mortgages, there are often measures to ‘cap’ the rate so that it cannot fall below a certain amount, making your repayments immune to the drop in base rate.
