The Bank of England (BOE) just unveiled a huge cut in the interest rate, in response to the economic impact the coronavirus coronavirus is set inflict on the UK economy.
The central bank said on Wednesday it would lower the interest rate by 50 basis points from 0.75% to 0.25%.
So what does this mean for the person on the street? Effectively, it means this is great news for those in debt but will hit savers hard.
When a central bank cuts interest rates, it’s a way to stimulate the economy. It makes borrowing cheaper, thereby allowing people have more pounds in their pocket and if there is a change in circumstance, allow them to pay debts off at a lower rate. It also encourages people to keep spending since the debt they incur will be cheaper to pay back.
But for those who are trying to save — this is bad news. It means that the money you squirrel away will accrue a small amount of return.
Mortgages and loans
For those on the housing ladder, a cut in interest rates should see a reduction in some monthly mortgage payments — but it depends what agreement you have.
If you are on a fixed rate mortgage, this means any changes to interest rates will not apply to you until that fixed-term is over. Don’t forget this also protects you from a rise in interest rates.
For those on variable mortgages, any changes to the interest rate come into effect almost immediately. Variable rate mortgage can be an amount that has a combination of a fixed interest rate plus the base rate — which is now returning to an all time low of 0.25%. This means that this will lower your monthly payments.
Tracker mortgages are those that track the interest rate movements so, again, a reduction in the interest rate will mean your payments are lower.
You can check what your mortgage monthly payments would be using this calculator.
“This is horrible news for savers, who have been struggling with rock bottom rates for the past decade, and now look set for even more woe,” said Sarah Coles, personal finance analyst, Hargreaves Lansdown.
“On the flip side, this may be better news for borrowers, especially for those on their mortgage lender’s standard variable rate. Not only will their rate fall, but there should also be rock bottom fixed rate deals around, so you can take the opportunity to fix for longer on a low rate.”
Any loans that are not purely fixed rate will see a reduction in monthly payments. Some loans are a combination of a fixed rate plus the bank base rate.
That means that any reductions in the interest rate, those loan holders should see a reduction in payments from the next cycle.
For businesses, there are emergency measures in place.
As well as the interest rate cut, the BOE released a new £100bn ($129bn) funding scheme aimed at maintaining bank and building society lending to small and medium-sized businesses. It will unlock £190bn they can use to lend to people and businesses that need it.
It would be worth contacting your bank to see what the options are.
Credit cards and overdrafts
Unfortunately for those with overdrafts and credit cards, the existing monthly payments won’t change. This is due the fixed rate nature of interest payments.
From April this year, many banks will be upping their overdraft fees to around 40%. Right now, it’s too early from the Bank of England’s announcement to see if banks will amend or reduce their charges on overdrafts and credit cards to help consumers.
It could be possible, as RBS announced it is allowing mortgage repayment holidays for those affected by the coronavirus.
Savings and pensions
Savers are usually the hardest hit.
A cut in interest rates is generally bad for those who are putting cash away for a rainy day or in a pension or a Individual Savings Account.
The rate of return is likely to be lower for those opening up a new account and those with an existing account may see little or no return.
Pensions are a mixed bag. There is greater concern over pensions being affected due to the stock market movement than from the interest rate cut right now.
A lot of pensions are linked to financial markets and instruments. For example, the pot of money may be linked to the stock market. However stock markets are being hammered due to the coronavirus outbreak impact on the economy and therefore shares are sliding. This is likely to have the biggest impact on pensions right now.
Pensions are a long term play, so the health of the economy is more important element to consider when looking at these investments.
Where should you put your money?
When interest rates are low, paying off your debts is the most sensible way to move forward. If you have a choice of putting money into a savings pot or paying off a loan, it’s best to pay off debt.
This is because it will be cheaper for you to do it, reduce your monthly outgoings, and safeguard you better if there is a greater downturn in the economy or if you lose your job.
If you have savings sitting in an account accruing little return or none at all, but you have debts in the thousands that accrues large interest payments each month — you’re losing money.
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