The Bank of England has cut interest rates from 4.75% to 4.5%, their lowest level for 18 months.
It is the third cut since August 2024, but the Bank said it will take a “cautious” approach to further reductions.
What are interest rates and why do they change?
An interest rate tells you how much it costs to borrow money, or the reward for saving it. The Bank of England’s base rate is what it charges other lenders to borrow money. This influences what lenders then charge their customers for loans such as mortgages, as well as the interest rate they pay on savings accounts. The Bank moves rates up and down in order to control UK inflation – which is the increase in the price of something over time. It has a target to keep inflation at 2%.
When inflation is high, it may decide to raise rates to bring inflation back down. The idea is to encourage people to spend less and reduce demand. Once inflation is at or near the target, the Bank may hold rates, or cut them.
How do interest rates affect mortgages, loans and savings rates?
Mortgage rates
Just under a third of households have a mortgage, according to the government’s English Housing Survey, external.
About 600,000 homeowners have a mortgage that “tracks” the Bank of England’s rate, so a base rate change has an immediate impact on monthly repayments. A 0.25 percentage point cut would typically save them about £29 on their monthly repayments, according to figures from lenders’ trade body UK Finance.
But more than eight in 10 mortgage customers have fixed-rate deals. While their monthly payments aren’t immediately affected, future deals are.
Mortgage rates are still much higher than they have been for much of the past decade.
As at 6 February, the average two-year fixed mortgage rate is 5.50%, according to financial information company Moneyfacts, and a five-year deal is 5.30%. The average two-year tracker is 5.46%.
It means many homebuyers and those remortgaging are having to pay a lot more than if they had borrowed the same amount a few years ago.
About 800,000 fixed-rate mortgages with an interest rate of 3% or below are expected to expire every year, on average, until the end of 2027.
A hold in interest rates may have relatively little impact on pricing of fixed-rate mortgages in the short-term. The outlook is complicated at the moment as the markets, and lenders, consider the impact of the Budget and other global events. However, the prospect of further falls could give impetus to lenders to cut their rates for new borrowers.
You can see how your mortgage may be affected by future interest rate changes by using our calculator:
Credit cards and loans
Bank of England interest rates also influence the amount charged on credit cards, bank loans and car loans.
Lenders can decide to reduce their own interest rates if decisions by the Bank of England make borrowing costs cheaper. However, this tends to happen very slowly.
Image source,Getty ImagesSavings
The Bank of England interest rate also affects how much savers earn on their money.
A falling base rate is likely see a reduction in the returns offered to savers by banks and building societies. The current average rate for an easy access account is about 3% a year.
Any cut could particularly affect those who take the interest from savings to top up their income.
