How the Bank of England Base Rate Impacts your Mortgage Rate

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Changes in the Bank of England base rate can impactdifferent people in different ways. This can depend upon whether you’re on atracker, discount or SVR mortgage when that rate does change.

The current Bank of England base rate
The base rate is currently sitting at 0.25%, which is ahistorically low level, despite being even lower prior to the 16th of December2021, when it sat at 0.10%. This even more historic low was put in place as areactionary measure to the COVID-19 pandemic in an attempt to shun the economicimpacts of the pandemic and increase spending/borrowing.

The increase from 0.10% to 0.25% is in an attempt to reducethe impact of inflation, which has risen to 5.1% as of November 2021 in theaftermath of the core pandemic impact upon the economy. This is significantlyhigher than the usual Bank of England target of 2% inflation.

The below graph provided by the BBCshows just how low the Bank of England base rate has dropped over the years.The primary driver of this being the aftermath of the 2008 Financial Crisis:

Understanding the base rate

In simple terms, the base rate is the cost at which the Bankof England will lend money to commercial banks. This is their interest rate.

The base rate will also have an impact on Swap rates whencommercial banks lend to one another. Therefore, if the base rate rises orfalls, this cost is then passed on to the consumer of the bank by raisinginterest rates on their lending products (such as Mortgages, Personal Loans,etc).

It will impact individuals two-fold. Firstly, it will impacthow expensive/in-expensive it is to borrow money. This will be specificallyimportant for those looking at long-term lending, such as a mortgage. But itwill also impact how much interest you are earning on your savings. These arecorrelated. When it is cheaper to borrow money, you will earn less on yoursavings. When you earn more on your savings, it will cost more to borrow.

Why does the Bank of England base rate change?

The Bank of England base rate will be changed based on avoting procedure by the Monetary Policy Committee (MPC). They will meet eighttimes a year in order to vote upon the current base rate. Although it is worthnoting that the rate can stay the same in all eight meetings, and does not haveto change.

The decisions made by the MPC is based upon the currenteconomic circumstances of the UK, with the main aim to keeping inflation in andaround 2%

But how does the base rate impact inflation? While I highlycomplex economic chain reaction, it can be simplified in the following way:

If the base rate islow, it is cheap to borrow. Therefore, this inherently increases spending, aspeople purchase more houses, take out car loans, start businesses with businessloans, etc. Due to the spending, this will cause an increase in inflationnaturally. Conversely, if the base rate is high and borrowing is expensive,people will save their money instead of spending and borrowing. Less spendingmeans a natural deflationary impact as businesses need to reduce prices inorder to entice people into spending their money. Suppliers reduce costs, whichhas a chain reaction impact throughout the whole economy.

How will a base rate change impact yourmortgage?

The type of mortgage you have will be the main determiningfactor as to how a base rate change will impact you. If you are on avariable-rate mortgage, you are going to be impacted the most by a change ofthe base rate, and it will impact your repayment amounts.

However, if you are on a fixed-rate mortgage, then you willnot feel the impact of a base rate change until after your fixed period.

Impact of a Tracker Mortgage

A tracker mortgage, as the name suggests will ‘track’ theBank of England base rate, as well as a margin set by your bank. For example,it could be the base rate + 1%. Therefore, if the base rate is currentlysitting at 0.25%, your mortgage rate would be 1.25%

The impact here is that if the base rate increases, so doyour mortgage in line with the increase. However, conversely, you can alsorecognise that a reduction in the base rate will cause a reduction in yourmortgage rate. During uncertain times when the base rate fluctuates, you willfind that your mortgage payments will vary significantly as the rate changes.

Impact of an SVR Mortgage

SVR or Standard Variable Rate is the most common setup whenyour fixed term period has ended. Most commonly people will remortgage toanother deal at the end of a fixed term in order to avoid an SVR, as the ratestend to be higher and they are greatly impacted by fluctuations in the baserate.

Impact of a Fixed Rate Mortgage

A fixed-rate mortgage will provide a temporary safe-havenfrom base rate fluctuations, as they will guarantee your fixed interest ratefor a set period of time. However, if you allow this mortgage agreement to end,then it can lead to a significant hike in your rate to an SVR. It is oftenimportant to be vigilant towards the end of your fixed period and begin lookingfor better deals.

It is generally thought that during times of aconsistently low base rate, a fixed mortgage is the best approach. Especiallyduring the current times where the base rate cannot really go much lower.However, during times when the base rate is high, a fixed-rate can work againstyou if the rate suddenly drops, but as you are fixed, you are left with thehigher rate.