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Interest rates cut to unprecedented low of 0.25%

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Written by: Paloma Kubiak
04/08/2016
Long-suffering savers have been dealt another blow but it’s good news for mortgage borrowers as interest rates have been cut to a new record low of 0.25%.

Until today, the Bank of England Base Rate had been held at 0.5% since March 2009.

In the second meeting of the Bank of England’s Monetary Policy Committee (MPC) since the UK’s momentous Brexit decision, members unanimously voted to cut the Base Rate to 0.25%.

This is the lowest the rate has ever been and is a long way from the record high 17% interest rate recorded in November 1979.

The MPC decision came just days after the markets priced in a 98% chance of interest rates being cut.

The Bank of England also announced the purchase of £60bn additional government bonds extending its asset purchase programme from £375bn to £435bn. It additionally announced a new scheme of buying up to £10bn of UK corporate bonds.

How does the interest rate affect you?

I am a saver

It’s bad news for you as you’ll have to put up with dismal savings rates for longer. Hargreaves Lansdown said given the current interest rate expectations, it now looks like the UK will endure a decade without a rate rise. Since October 2008, it estimates savers have lost out on £160bn in interest on their cash accounts, the equivalent of £6,000 per household (compared with the interest rate they were receiving in October 2008).

High paying interest rate accounts have pretty much disappeared. Independent research site Savings Champion said since 2012 it has seen around 4,700 cuts to existing savings accounts. The current average easy access account interest rate stands at 0.65% for both live and closed products.

Given the prolonged low interest environment, Tom Stevenson, investment director for personal investing at Fidelity International, said now could be the time to move up the risk spectrum to receive an increase in returns.

“For anyone who is unsure about the benefits of investing in the stock market our calculations show that if you had invested £15,000 into the FTSE All-Share index 10 years ago you would now be left with £25,323. If, however, you had invested £15,000 into the average UK savings account over the same period, you would be left with a paltry £15,976. That’s a difference of £9,347 – far too big for anyone to ignore.”

I am retiring

Low interest rates are also bad news for people buying an annuity – a guaranteed income in retirement. Annuity rates have already fallen to record new lows – a £100,000 pot now gets an annual income of £5,000 – following the Brexit vote and are expected to fall further.

Kate Smith, head of pensions at Aegon, explains that annuity rates are affected by a number of factors including people’s life expectancy, gilt yields, as well as customer demand and regulation.

“There are two main factors driving down the rates. Firstly, insurers price annuity rates in relation to yields on gilts and corporate bonds. UK gilt yields are currently at their lowest ever level having fallen to around 1% and dipping into negative territory in recent weeks as a result of low interest rates combined with investor’s search for low risk assets.

“Annuity insurers buy gilts and bonds as they give predictable returns meaning they are suited to annuities which provide a guaranteed income for life. If the returns on these investments are low when the customer buys the annuity, this is reflected in their annuity income, and they will get less for their money.”

Following the cut in interest rates, it’s likely we’ll see a further drop in gilt yields which will have a negative impact on annuity rates and defined benefit pension deficits.

Andrew Pennie, head of pathways at Intelligent Pensions, said annuity rates have fallen 12% since the start of the year so it’s no surprise many people are choosing not to buy an annuity under the new pension freedoms in the hope that future rates might improve.

“But for some people annuities are the right retirement solution and there is no advantage in deferring for several months – or years – in the hope that rates rise again. The cut in interest rates typically makes stocks and shares more attractive and people with pensions exposed to the markets could see a jump in the value of their pension savings.

“The cut and likely fall in gilt yields may also benefit those people looking to transfer their defined benefit pensions to take advantage of the new pension freedoms. The cost of securing future income will now be more expensive and hence transfer values should rise to reflect this.”

I have a mortgage:

The exact way you may be affected depends on the type of mortgage you have:

Variable rate: There are an estimated 4.9 million borrowers on a variable rate mortgage, usually applied after you finish an introductory, tracker or fixed rate product. The rates are set by the lender so they can go up as well as down. As the Base Rate has lowered, lenders may cut their Standard Variable Rates (SVR) which could mean your monthly payments fall. However, if you’re on a lender’s SVR, this is usually more expensive than a tracker or fixed term mortgage, so it’s likely you’ll be overpaying anyway. It may be worth looking to switch to a fix (see below) to benefit from the cut in interest rates.

Tracker rate: There are an estimated 1.8 million tracker mortgages in the UK. Tracker rate mortgages are a type of variable rate mortgage and they follow the Bank of England’s Base Rate. However, they don’t match the rate exactly so the rate you pay may be at a margin above this. As it has fallen 0.25%, you should benefit from lower repayments while if the interest rate was increased, it’s likely you’d have to pay more each month.

Hannah Maundrell, editor in chief of Money.co.uk, said homeowners on tracker mortgages are likely to save about £34.95 a month (£420 a year) on a 25-year £170,000 mortgage. Though she added if you benefit from the cut, the best course of action will be to keep on paying the same amount so you knock down your capital, or store the excess as fall back money.

Fixed rate: If you’re on a fixed rate mortgage, you should not see any change to your monthly payments. Jeremy Duncombe, director, Legal & General Mortgage Club, said that fixed rates have been falling consistently since 2009 and many lenders have already priced into their products and deals such a reduction. He added that a few lenders will look to drastically amend their offers off the back of today’s news.

Potential borrower or remortgagor: If you’re a first-time buyer, the mortgage market is fiercely competitive and for those looking to remortgage, mortgage rates are at historic lows for longer term fixes. Just last month, three lenders announced sub-3% 10-year fixed rates, allowing homeowners to lock into longer-term mortgage payment security.

Duncombe said: “The fact remains that current fixed rates represent a good deal for consumers, and borrowers would be prudent to use these prevailing circumstances to speak to an adviser about remortgaging options available to suit their individual financial needs.”

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