What can you do to manage higher interest rates? - Rest Less (2024)

Interest rates have risen consistently over the last couple of years to tackle rising inflation, which has left many of us feeling financially stretched.

However, in August the Bank of England’s Monetary Policy Committee finally reduced the base rate to 5%, down from 5.25%. While this might be a big relief for people worried about rising borrowing costs, interest rates will likely remain high over the next couple of months so it’s important to think about how this affects your finances.

Here, we look at what makes interest rates change and explore some of the ways to approach higher rates.

Contents

• Why do interest rates go up?
• What do higher interest rates mean for me?
• Will higher interest rates affect my mortgage?
• Will higher interest rates affect my loans?
• Will higher interest rates affect my savings?
• Will higher interest rates affect my pension and investments?

Interest rates usually rise when inflation, or the rate at which living costs are increasing, is too high.

When borrowing costs rise, it makes it more expensive for people to spend, which helps dampen economic growth and slows inflation.

Following 14 consecutive increases in the base rate since November 2021, inflation finally began to ease in late summer 2023, and stood at 2.2% in the 12 months to July 2024. Interest rate increases were on hold while inflation was falling, and the Bank of England could cut rates in response to this in August 2024.

Generally, when interest rates rise it has two key impacts: savers are better off as their savings earn more interest and borrowers are worse off because rates increase on financial products such as loans, mortgages and credit cards.

The impact higher rates may have on you therefore depends on your individual circ*mstances, and how much you owe and have in savings, along with whether the products you have are on fixed or variable rates. If, for example, you have a fixed rate savings account, the amount of interest you earn will remain the same during the fixed rate term regardless of whether interest rates rise or fall.

Whether higher interest rates will affect your mortgage depends on the type of mortgage you have.

If you have a fixed rate mortgage, for example, you’ll have signed up to pay a set interest rate over a specific period of time (i.e. 5.2% for two, three or five years etc). As your mortgage rate is fixed, your monthly payments won’t change if interest rates go up. The key risk is when your fixed term ends as unless you remortgage, you’ll move on to your lender’s Standard Variable Rate, which could be higher than you anticipated, as the SVR will usually increase as interest rates rise. If you do remortgage, although you’re likely to find a much better deal than the SVR, you may still find that you’re on a higher rate than you were previously if interest rates have gone up.

If you have a variable rate mortgage, you’ll normally see your monthly costs rise if interest rates go up, although it will be up to your lender whether they pass on an increase in full. You will definitely see an increase in your monthly repayments if you have a tracker mortgage where your rate tracks the Bank of England base rate, plus a set percentage. While the Bank of England reducing the base rate to 5% in August will be a relief to many, lots of people will still be facing high mortgage rates as a result of the last 14 consecutive rises.

If you are concerned about rising interest rates affecting your mortgage there are a few things you might be able to do to help protect yourself from the impact.

Generally, when you apply for an unsecured loan such as a car on finance, credit card or a personal loan, you will agree to a fixed interest rate for a period of time, so rising interest rates are unlikely to have an impact on your monthly repayments. One exception to this rule is that it is possible that your credit card lender could increase their interest rates and pass this on to you, however they have to notify you first and provide you with an appropriate length of time before the interest rate is brought into effect.

If you are worried about how rising interest rates might affect your loans or credit cards, there are a few things you can do to take more control:

• Drive down the amount you owe – better than any other defence method, reducing the amount you owe is your best bet to minimise the impact of rising interest rates. If at all possible, it’s best to pay off what you owe before saving as the interest rates you are likely to be charged on what you are likely to be higher than the interest you could earn on your savings. Everyone’s situation is different so make sure you can afford these payments before you start.
• Know your lender’s interest rise notice period – lenders legally only need to give you 15 days notice before increasing interest rates, so don’t assume that just because you signed up to one interest rate that you will always be paying that.

The good news is that savers are the ones who really benefit from higher interest rates – as long as their savings provider passes on the rates, as they don’t have to unless your account has a rate that tracks movements in the base rate.

Banks and other financial institutions will often compete to offer new customers the best interest rates, so if you have savings and your provider doesn’t pass on a rate increase it can be a great idea to shop around to find the best deal for you. Our articleWhich cash ISAs pay the most interest?highlights which cash ISAS currently pay the highest returns.

Many pension funds automatically move investors into bonds and cash as they approach retirement, as they are considered less volatile and risky than stocks and shares. A bond is effectively an IOU for a loan, either to a company or a government. If you invest in a bond you receive interest on the loan (normally at a fixed rate), with the capital being paid back at the end of the term. A company bond is called a corporate bond and a UK government bond is a gilt.

When interest rates rise, bond prices tend to fall and their yields increase. Conversely, when interest rates go down, bond prices rise and yields fall, as investors are often tempted back to cash savings when savings accounts are paying higher interest rates.

Steeper interest rates can therefore have a big impact on the value of your pension savings if you have a significant amount invested in bonds or gilts. It’s therefore vital to check where your pension is invested to see how you might be affected by a change in interest rates. Find out more in our article Where is my pension invested?

It’s worth noting that rising bond yields can be good news for anyone looking to buy an annuity, or income for life, as it should mean they are able to secure a better income stream. Find out more about how annuities work in our article Annuities explained.

If you want personal recommendations about where to invest your retirement savings, or what to do with your pension once you reach retirement, you’ll need to seek professional financial advice. You can find a local financial advisor on VouchedForor Unbiased, or for more information, check out our guides on How to find the right financial advisor for you or How to get advice on your pension.