WHAT 3 YEARS OF LOW INTEREST RATES MEANS TO YOU

Today marks the 3rd anniversary since the Bank of England reduced the base rate of interest rates to its historical low of 0.5% in the UK. They reaffirmed this decision today. This has got us to thinking about how this has affected us, and what the implications could be for the future.  We will hopefully show you some ways in which you can take positive action to overcome some of the issues raised.

What is the Bank of England base rate?

The Bank of England’s job is to set interest rates in an attempt to keep inflation within acceptable limits. It’s target is price growth of 2% as measured by the Consumer Prices Index (CPI), which in theory would deliver stable growth for us (not too low or high). Changes in interest rates are intended to affect the overall level of spending in the economy.  By raising interest rates, this makes goods more expensive, and reduces demand; low interest rates keep lending costs down, and in theory increase demand. The Bank of England base rate is the rate at which the Bank lends to other financial institutions.  This rate therefore should affect the rates at which these banks then lend to consumers and businesses, as well as the interest rates they pay on savings. The Bank decides on the rate each month through a special committee.  The job of this committee is to predict how the economy will look in the future – at least a year ahead – since often the effects of their decisions can take that long to filter through the system.

What has low interest rates meant for us?

Low borrowing costs With consumer demand remaining low, high unemployment and a fragile economy the Bank of England has taken action to help embattled householders and businesses.  Mortgage costs remain relatively low, although the difference between the Bank of England’s base rate and the standard variable rate of many lenders remains quite large. This is obviously good for many people, and has probably meant that they can struggle on with their repayments, in contrast to how things went in the last big recession. Our concern is that many people have slipped from initial fixed rate loans onto standard variable rates.  While these look attractive at present, when interest rates inevitably rise this will push up the costs of mortgages quite significantly.  This could have a disastrous effect on people who have not planned for this, or are unable to. We would recommend that you take stock now and make an informed decision as to what might happen if interest rates rise by a few percent.  Waiting for this to happen might mean that you take action too late. If you are finding that you have reduced your mortgage payments, you could consider overpaying on your mortgage.  This will give you a guaranteed theoretical return on your money far greater than what would be available through a bank account.  If you can afford to, you should be pushing down your mortgage or loan balance as quickly as possible. Read our mortgage advice client case study. Low savings rates While low interest rates benefit borrowers, they are bad for savings accounts.  Most bank savings account are paying very low rates, almost always below that of inflation, which means that if you have money on deposit you will be effectively losing money in real terms over time; as well as this, savings are usually taxable.  This problem is particularly felt by the retired who might not be able to earn more to replace these losses.  One temporary solution could be to shop around for better rates.  You can easily move savings to a new provider, and this applies to ISAs as well. However, you should be wary of sharp marketing tactics by the banks.  Often they tempt you in with a short-term introductory offer, reducing the rate significantly after a few months; remain vigilant! A more strategic solution might be to consider a different approach such as investing your money in different types of assets.  This might mean taking slightly more risk with you money, but this might be the only way that you can achieve a decent level of income in the medium term, and also have the chance of outpacing inflation over time as well.  Of course, this sort of action should only be taken with the help of a financial adviser – and not one from your bank! Check out our investment management service. Lower pension annuity rates This year represents one of the busiest years for retirements due to a population bulge after the second world war.  Therefore the issue of retirement income is particularly relevant today.  Unfortunately, with low interest rates, Bank of England quantative easing, and longer life expectancy this has gradually reduced the income levels paid out by pension  schemes through retirement annuities.  We have seen pension annuities pay out lower incomes in recent years. The solution should be that you should never accept the annuity offered to you by tyour pension provider.  They might offer you the best income rate on retirement, but they probably won’t.  Think of it like whenyou renew your car insurance – the renewal price is rarely the cheapest on offer.  We recommend taking the Open Market Option and shopping around for your retirement annuity.  This can boost your retirement income by more than 25%, and by a greater amount if you have any underlying medical conditions.  This is the one way in which you can recoup some of the income losses of recent years. Read our retirement annuity case study.

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Dan Woodruff

Certified Financial Planner & Chartered Wealth Manager at Woodruff Financial Planning
Financial Planning helps you to navigate and anticipate significant life changes. I want to help you to ensure your money is managed wisely to give you the financial security that will fund the future and lifestyle that is important to you.

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