The Impact of Interest Rate Changes

When the monetary policy committee decides to change its interest rate, the effect is that all banks and similar deposit-takers have to follow suit and alter the interest rates at which they lend and borrow by something like the same amount.

This means that the banks base rates are inevitably variable rates, because they follow the bank of England’s rate that is adjusted as necessary to put into operation the monetary policy used to control the economy of the UK.

Until fairly recently, most loan interest rates, including secured loan, and mortgage rates, were variable rates. A major disadvantage of variable rates, particularly in relation to a large transaction such as a mortgage or secured loan, is that it is difficult for the borrower, whose income does not vary in the same way, to budget for likely future expenses. Sudden large rate increases can lead to borrowers being unable to make their secured homeowner loan or mortgage repayments, and in the worst cases some may cases some may even lose their homes if the lender has to take possession.

With the development of a large and active wholesale money market, it is now possible for lenders to obtain large amounts of money at fixed rates, which they can in turn lend out to their mortgage and secured loan borrowers. Fixed rate mortgages in the UK still tend to be fixed for only a short initial period, with the rate reverting to the variable rate for the remainder of the term. Longer term fixed rates are available in many other European countries, and it has been suggested that a greater use of long-term fixed rates in the UK would assist in stabilising the sometimes very volatile British housing market. Fixed rate mortgages do have their own disadvantages, not least of which is the danger that a borrower will lose out if the variable rate falls and they are locked into a fixed rate. There is normally a penalty for paying off the mortgage within the fixed rate period, in order to protect the lender. There may also be an arrangement fee, charged by the lender for reserving sufficient funds at the fixed rate.