Deep Dive

WTF are Interest Rates?

Emma Nunes-Vaz
January 16, 2024

The UK interest rate has just risen to 2.25% - the highest level since 2008, signalling that a recession has started! 😱 The Bank of England has made this decision in order to tackle the rising inflation the economy is currently facing due to the cost of living crisis - but what does this actually mean? As always, Incredible’s got you covered 😎

What is it?

Interest rates themselves are essentially the charge that comes with borrowing money; whether that’s on a credit card, through a mortgage, student loan etc - but also the reward you get for saving your money. The higher the interest rate, the more expensive the loan will be for the borrower; yet also the more interest (higher reward) you’ll earn on your savings. Then there’s the Bank Rate, which is set by the Monetary Policy Committee (within the Bank of England) in order to attempt to keep inflation low and stable. It sets the amount of interest paid to banks, which therefore determines the rates they charge customers for borrowing, or pay them for saving.

Why are they rising? 

The Bank of England has stated that ‘higher interest rates make it more expensive for people to borrow money, encourage people to save and, overall, mean that people will tend to spend less.’ Rather than stimulating people to spend more on goods and services during periods of economic decline and rising inflation, if they instead are encouraged to spend less on them, the demand and therefore prices of those things tend to rise more slowly. Slower price rises mean a lower rate of inflation, allowing the economy to (hopefully) stabilise. 

What does it mean for me?

As we’ve explained, higher interest rates will mean it’s more expensive for you to borrow money (unless you have a fixed rate), yet also (theoretically) more rewarding to save it. However, many banks are yet to pass on the last six base rate rises to savers - and those that have have been very slow about it. 

The BofE have shared a simple example as to highlight how rising interest rates can affect your borrowing:

Imagine you have a £130,000 mortgage that you want to pay off over 25 years. If the interest rate on the mortgage is 2.5%, the monthly repayment will be £583. But if the interest rate is 1% higher, the monthly repayment will be higher, at £651. Of course, interest rates can go down as well as up. If the mortgage interest rate was 1% lower, the monthly repayment would be around £520.

The reality of the situation is that it remains unclear, so the best thing to do is monitor the changing rates closely and make sure you have a good grasp on your finances. This includes understanding whether your borrowings have a fixed interest rate or not, and calculate what this means for the ones that don’t. As we continue our path towards this uncertain economic future, we also recommend you follow us in order to stay in the loop on financial news, as well as use our tips and tricks to save yourself money and spend less on your borrowings. Good luck everyone, and we’ll be sure to keep you informed 🖤