How Rising Interest Rates Affect Us
It was recently announced that interest rates went up from 0.25% to 0.5%. But what does it actually mean for the average person in our everyday lives if interest rates increase?
Are mortgage rates going up?
The biggest impact on rising interest rates for the average person will be on what we pay for our mortgages.
If you’re on a fixed rate, you’ll be unaffected immediately but will most likely pay a higher monthly amount if the rates remain the same, or higher, when your fixed term ends and you want to re-mortgage.
If you’re on a variable rate, your monthly payment will most likely increase for your next payment.
Bank Account Interest Rates Increase
On the opposite side of the coin is that with banks charging more interest on our mortgages, they may also pay us more interest on our savings.
Whether your bank increases the interest rate it pays savers will be completely at your bank’s discretion. They don’t have to increase what they pay savers. History tells us this is less likely than the mortgage rate increases.
If you’re on a fixed rate with your bank account, your rate will not change regardless of today’s decision.
Rising Interest Rates Affect On Pensions & Investments
Another way interest rates affect us is if we are invested in Bonds.
Simply speaking, if we bought a bond last week for £100 (when interest rates were 0.25%), we would earn £0.25 every year for the duration of the bond. If we bought the same bond now (with interest rates at 0.5%), we would instead earn £0.50 per year.
Hopefully, this helps your core understanding of bonds, however, bonds are much more complicated than this because they have an end date, they can be bought and sold during the bond period and different bonds have different yields and durations.
For current bondholders, the downside to interest rate rises is that the value of current bonds decreases (generally speaking).
This is because if you bought a bond that pays £1 for every £100 you originally invested (an interest rate of 1%) but current interest rates are 2%, it means that no one would buy your bond from you for £100 to earn £1 if they can buy a new bond for £100 and earn £2 (double the return). The result of this is that the value of your bond is more likely to be around £50 than it is £100.
Realistically, the bond markets are always adapting and anticipating changes in bond prices and interest rates so most interest rate changes are already factored into bond prices. They’re also never as dramatic as dropping in value from £100 to £50, like in the example above, because at the end of the bond term, whoever owns the bond gets the full £100 back.
Rising Interest Rates Summarised
To summarise, there are good things and bad things about interest rate increases. How they affect you will depend on your individual circumstances.
The media will generally only tell you about the bad parts, but it’s important to remember the benefits too.
by Ross Megretton