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What to do if interest rates rise?

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A week or so before I wrote this article, there was a lot of concern that the Bank of England was going to increase interest rates. People were flapping about and wondering what they would do if the interest rates DID rise. Then nothing happened and they stayed at 0.1%

There was a collective sigh of relief (mostly from our bank accounts), but it did serve as a warning. Now is the chance to get our financial situation in order so that we can avoid some of the potential impacts that might come along with this.

What is this interest rate thing then?

Well, the Bank Of England is tasked with the job of keeping inflation (how much more expensive things are getting) at around 2%. That is the Government’s target. The BoE sits outside of the Government itself so that it can remain neutral in its decision making.

Now the main way that inflation is controlled is through interest rates and the Bank of England are the one that can set the base rate. Now the Bank of England are essentially the bank for banks. They pay interest on money that the banks hold with them and charge interest on any money borrowed.

Therefore, if becomes more expensive for them to borrow money, then they’ll pass it on to the likes of you and me. And that’s exactly what the BoE want to happen.

A quick lesson on inflation

Inflation is the rate at which things are getting more expensive. Like I said 2% is perfect, but anything less or more and it could cause issues. The BoE decided to drop the base rate back at the start of the pandemic. This meant that things like mortgages were cheaper and saving money sucked, so we spent more. This is what they wanted to happen because it kept the economy going at a time when it should have stopped.

But now everything (ish) is open again and we are still benefitting from having this extra cash (even if it doesn’t feel like it). As a result, there is more demand for stuff and well supplies are a bit of an issue at the moment. The result is prices go up aka inflation.

The solution then is to make us have less money and one way to do this is to hit us where it hurts – mortgages. If our mortgage payments go up, then we have less to spend. Demand drops and prices don’t go up as quick.

We might also be tempted to saving more if we get a better interest rate there too. Ultimately, it becomes a double-pronged attack to get us spending less.

What should you do if interest rates rise?

Well, what’s more important is what you do before they rise. I have a couple of suggestions for you here.

1. Get the best deal for your mortgage

If you are on a variable tracker mortgage, then any interest rate increase will have a near-immediate effect on your mortgage payment. You’ll want to consider whether you would be able to afford this increase and any increases in the future.

Now if you are on a fixed deal then you going to be able to stay at the lower price for a while. But if you are coming to an end you may want to shop around and lock in those lower interest rates for as long as possible. You may want to speak to a mortgage adviser to get advice that is tailored to your situation.

2. Overpay your mortgage

This works both ahead of an interest rate increase and if you are on a fixed rate deal after the increase. But you may want to consider overpaying so that your mortgage balance is less when you need to remortgage in the future.

The lower your loan to value (LTV) ratio, the more likely you are to get lower interest rates in the future. Basically, the more of your home you own compare to what you owe the better. Therefore, overpaying your mortgage could help you slip into a cheaper category.

Beware though that there are other things that you could do with this “spare cash” that could potentially provide you with a higher return, such as investing or paying into a pension. Again you might want to get some advice on this first.

3. Improve your credit score

Just like with overpaying your mortgage with the hopes of improving your LTV ratio, improving your credit score can help too. A better credit score might give you access to better rates in the future.

You might want to look at how you are currently using debt and whether you have been consistent in paying your bills on time. If you feel your track record is less than perfect, then maybe turn your attention this way for bit. It could pay off in the end.

4. Sort out the rest of your finances

Ultimately, paying more on your mortgage could lead to a strain on other areas of your finances. Therefore, taking a more holistic approach is probably a wise idea. Look for areas where you may be overspending or subscriptions that need cancelling.

You might want to look at your other debts too and see if there is a way to clear some of these to free up some extra cash each month. Essentially anything that you can do now to lower your costs going forwards is going to give your more options in the future.

Be prepared

That’s the simple message here. Given that the interest rates are so low and inflation is on the up, it feels inevitable that they are going to turn upwards at some point. If you are in the fortunate position where you can

Disclaimer:  Remember the information you read here does not represent advice.  Any ideas or suggestions are just that and may not work for you.  Read the full disclaimer here.

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