Interest is the cost of borrowing money or the reward for saving. In simple terms, when you borrow money, you pay interest. When you lend money, you earn interest – easy!
You might not have realised it, but interest rates affect most of us. In fact, a change in interest rates can impact your day-to-day life; from the cost of getting a mortgage, through to the prices of everyday products.
An interest rate is the percentage charged on the total amount you borrow or save.
If you’re a borrower, the interest rate is the amount you are charged for borrowing money – a percentage of the total amount of the loan. You are paying for the privilege of borrowing money, so that you can buy something now and pay for it later.
If you’re a saver, it’s the same except the interest fee is paid to you. When you deposit funds into a savings account, you’re essentially lending the bank your money. In return for letting them borrow your money they will pay you an interest charge.
The single most important interest rate in the UK is ‘Bank Rate’. You can find our bank rate here.
It’s often referred to as ‘The Interest Rate’ in the news but many people call it the ‘Bank of England Base Rate’.
The Bank of England sets the ‘Base Rate’ eight times a year and use it in dealings with other financial institutions. This influences all the other interest rates in the economy, including various lending and saving rates offered by high street banks and building societies.
For example, in 2016 the Bank Rate was cut from 0.5% to 0.25%. This reduced the rates at which high street banks could borrow money from the Bank of England. In turn, banks were more likely to charge lower interest rates on the loans they made, such as mortgages, but also offered lower interest rates on savings accounts.
It can be confusing trying to keep up to date with the number of different interest rates available when you borrow or save. The interest rates set by commercial banks depend on more than just Bank Rate. For loans, other factors are considered, including the risk of not being paid back.
So the greater the risk, the higher the rate the bank with charge.
If you want to borrow money and interest rates rise, it becomes more expensive for you. Whether you’re looking to get a new credit card, or a mortgage to buy a house, it’s essential to think about what steeper costs mean for you.
For example, if you have a £130,000 mortgage with an interest rate of 2.5% and a mortgage term of 25 years (meaning your monthly repayments would pay the loan off in 25 years’ time.)
Monthly you would pay £271 in interest which amounts to £3252 each year.
If the rate increases by 1% you will pay £109 more monthly, spending an extra £1308 a year. This would cost you an extra £32,565 over the length of your mortgage term.
However interest rates can go down as well as up.
On the same mortgage contract, a decrease in the rate by 1% means you pay £109 less monthly, saving £1308 a year instead.
It’s so important to understand how a change in interest rates could impact your money.
Hopefully this blog has helped you get to grips with the basics. If you need any help with your mortgage, please contact our team of experts for professional, friendly advice. Call 0161 443 4548 or click here to book your free mortgage appointment.