Bank of England base rate: how are mortgages affected?

The Bank of England’s base rate is a very important figure at the heart of the UK economy. It determines how expensive it is for banks to lend and borrow money, and it influences interest rates on consumer loans and saving accounts.

With the current economic situation looking uncertain, there has been much talk about which way the base rate will go. On the one hand, the Bank of England recently dropped the base rate to encourage mortgage lenders to offer cheaper deals and reignite demand for mortgages.

On the other hand, inflation is at its highest since 1992, and showing no sign of slowing. In this situation, the Bank of England would normally raise the base rate to encourage more people to save their money, and to curb the high consumer spending that helps to fuel inflation. But this could force lenders to raise their interest rates, further damaging the housing market.

How does the base rate affect my mortgage?

The base rate is the rate at which the Bank of England lends to other financial institutions, who in turn lend to consumers. Interest rates tend to be one or two percentage points above the base rate, which is partly how lenders make a profit on loans. In a way, the base rate acts as a ‘guide’ for lenders setting interest rates.

So the base rate should have a direct effect on lenders’ interest rates – but this is not always the case. Interest rates also depend on many external factors.

This is what we have seen recently in the housing market: due to uncertainty about potential losses on current loans, most banks have ignored the lower base rate and kept their interest rates higher than the Bank of England hoped.

If the base rate stays at this rate or gets lower still, and lenders become confident about lending again, we may well see interest rates coming down, making mortgages less expensive.

However, if the Bank of England decide to raise the base rate (e.g. due to high inflation), lending rates will almost certainly go up with them – meaning mortgages become a lot more expensive, and the housing market may face a further struggle.

Should I consider remortgaging?

If you are coming to the end of your current mortgage terms, it’s advisable to look at what’s on offer. Most mortgages start charging the lender’s SVR (Standard Variable Rate) once fixed-rate terms have expired, which tends to be more expensive than fixed-rate or tracker mortgages.

Even though interest rates are higher than two years ago, you may well be able to find a cheaper deal by remortgaging. Banks are still looking to compete with each other, and only appear to be raising their rates when absolutely necessary (for example, they may want to limit new business if they are uncertain about the market).

And even if you take out a remortgage with slightly higher repayment terms, a fixed-rate mortgage will ensure that your interest payments stay the same throughout – which could save you money if the base rate rises in the future.

That said, if the base rate falls, a fixed-rate mortgage could be more expensive than other types of mortgage (e.g. tracker or SVR) – so be sure to do your research on a) different mortgages and b) possible market conditions before you make a decision.

Finding a good deal also depends on your credit history, your earnings and your LTV ratio*. If you have regularly kept up on payments and/or you earn a good salary, lenders are more likely to offer bigger mortgages with lower interest rates.

*LTV ratio: Loan-to-value ratio – how much you are borrowing from the bank in proportion to your initial deposit (e.g. if you buy a £100,000 house with a £20,000 deposit, you will be borrowing £80,000 – so your LTV ratio is 80%).

Tags: mortgage, mortgages, bank of england, base rate, bank of england base rate

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