interest rates

Prepare now for rising interest rates

The long-awaited hike in base rates could come sooner than you think

As the economy recovers, some experts say the Bank of England could hike rates from today's all-time low of 0.5% as early as next year. Their predictions might be a little premature, but at some point in the next few years, rates will rise, and it will prove a shock for many when they do.

That day can't come soon enough for savers, who urgently need some respite from today's disastrous savings rates. Basic rate taxpayers need to earn 2.75% on their savings to keep ahead of inflation, while higher rate taxpayers need 3.67%.

Right now, the best easy access savings account pays just 1.5%. The only way to match inflation is to lock your money away for three years in a fixed-rate bond, but most people won't want to do that. All you can do is shop around for the best rate you can find, and if you are a taxpayer, make good use of your annual cash Isa allowance. You can save up to £5,760 in a cash Isa this year, and take all the interest free of income tax.

The dreaded hike!

In contrast to savers, anybody with a large mortgage will be dreading the first interest rate hike. If you're worried, you can protect yourself by taking out a fixed-rate mortgage. Almost nine out of 10 borrowers are doing exactly that. There is almost no point in taking out a tracker, as interest rates can hardly fall much further. Rates are far more likely to rise, and a fixed-rate mortgage gives you protection against that.

Better still, a two-year fixed rate is as cheap as a variable rate or tracker mortgage.The dilemma is how long to fix for. Two-year fixed rates have traditionally been the most popular, but they could have a sting in the tail. The problem is that your fix could expire just as interest rates are rising, making your next deal a lot more expensive.

By comparison, taking out a five-year fix now will protect you against base rate hikes until the beginning of 2019. You can get a two-year fixed rate from 2% up to 75% loan-to-value, while an equivalent five-year fix costs a little more at 2.8%. That would cost an extra £40 a month on a £100,000 capital repayment mortgage, or £960 over two years. 

But if interest rates rise, you may well claw that money back over the final three years of the deal. A longer-term fixed rate will also spare you the cost of remortgaging to another deal after a couple of years, which can cost hundreds of pounds in arrangement and valuation fees.

Younger people, or those who expect to move at some point, should think carefully before fixing for such a long period. But base rates have to rise at some point, and you must make sure you are ready when they do.

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