What are interest rates?

Interest rates affect most of us. You might not realise it, but a change in interest rates can impact your day-to-day life; from the cost of getting a loan, through to the prices of everyday goods.

An interest rate is a percentage charged on the total amount you borrow or save.

Even a small change in interest rates can have a big impact. It’s important to keep an eye on whether they rise, fall or stay the same.

If you’re a borrower, the interest rate is the amount you are charged for borrowing money – a percentage of the total amount of the loan. You can borrow money to buy something today and pay for it later.

Interest is what you pay for the privilege. It’s a bit like hiring a car. Interest is what you pay to ‘hire’ someone else’s money.

If you’re a saver, it’s the same except the interest fee is paid to you – because banks are paying to hire your money.

What is Bank Rate?

‘Bank Rate’ is the single most important interest rate in the UK. You can find our bank rate here.

In the news they often call it ‘the interest rate’ but some people refer to it as the ‘Bank of England Base Rate’.

We set the Bank Rate eight times a year and use it in our dealings with other financial institutions, which influence all the other interest rates in the economy. This includes the various lending and savings rates offered by high street banks and building societies.

An example of this is 2016, when the Bank Rate was cut from 0.5% to 0.25%. This reduced the rates at which high street banks could borrow money from the Bank of England. Banks were more likely to charge lower interest rates on the loans they made, such as mortgages, but also offered lower interest rates on savings accounts.

Why are there so many different interest rates?

The number of different interest rates available when you borrow or save can be confusing.

The interest rates commercial banks set depend on more than just Bank Rate. For loans, other factors are considered, including the risk of the loan not being paid back: the greater the risk, the higher the rate the bank will charge.

Why do interest rates matter to me?

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If interest rates rise, borrowing could become more expensive for you. Whether you are looking to get a mortgage to buy a house, or a new car on credit, it’s crucial to think about what steeper costs mean for you.

Imagine you have a £130,000 mortgage with an interest rate of 2.5% and a mortgage term of 25 years (meaning your monthly repayments would pay the loan off in 25 years’ time).

Monthly you would pay £271 in interest which amounts to £3252 each year.

If the rate increases by 1% you will pay £109 more monthly, spending an extra £1308 a year. This would cost you an extra £32,565 over the length of your mortgage term.

However interest rates can go down as well as up.

On the same mortgage contract, a decrease in the rate by 1% means you pay £109 less monthly, saving £1308 a year instead.

It’s key to understand how a change in interest rates could impact your money. You can use a mortgage calculator to work out how your monthly payments might be affected.

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