Q&A: What the interest rate cut means for you

The last year has been tumultuous in the world of finance. If you were fortunate enough to have your savings in a bank that didn’t go bust, and you managed to hang onto your job, you have still probably lost thousands from your pension as equity markets have collapsed.

But while property owners have suffered with the fall in the price of their homes some have benefitted from lower interest rates on their loans. The Bank of England has been steadily cutting the base rate and cut rates again by 0.5 percentage rate points on Thursday.

What effect have the interest rate cuts had on your personal finances? While the cuts have been good news for mortgage holders they have been bad for savers. How low could rates fall, and even if rates do come down further will lenders pass on those cuts?

David Black, principal consultant on banking at Defaqto financial research centre, shared his view and answered your questions on the effects of the interest rate cut on savers, mortgage holders and creditors.

.....................................................................................................................

Due to the high volume of questions we were unable to answer all individually, but tried to ensure that all major themes were covered

.....................................................................................................................

I’m keen to get my foot on the property ladder. Is the interest rate cut good news for me? How easy is it for first-time buyers to get a mortgage? Kate Pearson, Shepherds Bush, London

DB: There will come a time when house prices bottom out but no one can judge when this will happen or will know that it has happened until after the event.

Speaking to independent financial advisers I’m aware that some of them have affluent clients who have funds available and are merely waiting to judge the best time to buy residential investment properties.

In terms of getting a mortgage the main issue is likely to be the size of your deposit relative to the property price. The higher your equity percentage the keener the available mortgage deals become. If you decide to take the plunge it’s a buyers market out there at the moment and it may be worth offering well below the asking price.

.....................................................................................................................

With the bank base rates falling considerably over recent months, why have other types of borrowing other than mortgages failed to come down? For example, credit cards still charge around 16 per cent minimum for borrowing. Stuart Morris, Gloucestershire

DB: Historically very few credit card interest rates have reacted significantly to bank base rate changes. Personally I wouldn’t want to be a credit card provider at the moment as they’ve had many hits on their income (capped default charges; rapidly declining earnings on payment protection insurance sales; increasing levels of bad debts).

The thing that really surprises me about credit cards is the lack of reward for customer loyalty. The best deals tend to be restricted to new customers in the form of introductory offers. The majority of available credit cards either offer 0 per cent introductory balance transfer and/or 0 per cent introductory purchase offers. If you have a good credit rating there is, in my view, a big incentive to change your credit card on a regular basis whether you want to take advantage of 0 per cent introductory offers or cash-back rewards etc.

If you don’t have a good credit rating it’s very difficult and often impossible to get the best deals. Risk pricing is becoming far more prevalent and higher interest rates may get offered or applications may get declined. The credit card industry needs to change its psyche somehow and start engendering reasons for customer loyalty.

If you have a good credit card rating then take advantage of the introductory offers. And if you do so I’ve got one other tip (the providers will hate me for saying this): if you take out a 0 per cent balance transfer offer never use the card for anything else (ie. don’t use it for purchases) even if the card also offers a 0 per cent purchase deal. Get a different card to use for purchases. The reason for this is that the majority of cards allocate repayments to the cheapest debt first so you’ll be repaying the 0 per cent balance transfer capital before the purchase capital balance.

Where a card offers both 0 per cent balance transfers and 0 per cent purchases the duration of the 0 per cent purchase tends to be for a significantly shorter period than the 0 per cent balance transfer element.

.....................................................................................................................

I am due to re-mortgage in January and would ask how long should I hold off to allow the effect of the recent rate cut to take effect so that I can enjoy the better rates? Stephen Short, Newcastle Upon Tyne

DB: This really depends on what type of remortgage you’re after. For tracker mortgages the general expectation is that the margin charged over the bank base rate may increase. We’ve already seen some tracker mortgages get withdrawn. The other thing to look out for is minimum rate floors and collars, which mean the rates will stop tracking the base rate down at a certain level.

Fixed rate mortgages have not moved greatly but there have been some recent rate reductions.

When looking for a new deal keep an eye on application/arrangement fees as it is not unusual for providers to offer many versions of the same deal:-

* lowest application fee and highest interest rate;

* highest application fee and lowest interest rate;

Whether to go onto the Standard Variable Rate (SVR) is another imponderable. There is a huge difference between the SVRs charged by different lenders and your lender may or may not be offering a competitive deal. Many lenders will not accept new customers on to their SVR and use it solely as a ’go to’ rate after the expiry of your initial deal. As you’ll know there’s no guarantee with many lenders that SVR reductions will match the cut in the bank base rate.

.....................................................................................................................

I have a fixed rate mortgage with Nationwide taken out in August at 6.35 per cent for three years. I am considering paying the redemption charge of £2740 and taking a more competitive tracker mortgage. I am calculating that I could regain the redemption amount within the next two years and save money on top of this depending on the deal I can secure, but this is based on rates not increasing significantly during this time. How risky do you think this would be? John Briley, London

That’s a real poser and it’s something that you’ll need to take a view on. No one knows the answer but it is potentially risky. All I would warn is that sentiment or expectations as to the future direction of the bank base rate can change very quickly.

Also the margins above the bank base rate charged on tracker mortgages has increased significantly over the last 19 months and those who took out tracker mortgages in the autumn of 2007 made an inspired choice.

If I were in your shoes I would be tempted to have a chat with a no fees broker and get them to explain the risks and possible alternatives. In any event don’t forget to include the other costs of remortgaging in your calculations before making any decision.

.....................................................................................................................

I have just received £65,000 tax-free cash in a lump sum from my pension pot. With interest rates so low I’m worried about where to put my money so that I can get the best rate of interest. Where should I put my money? Anna Hawkins, Ealing Broadway

DB: Bank and Building Society savings rates are not good news at the moment and sadly are likely to decline further. Have a look at the best buy tables which appear in newspapers and on various websites.

Start off by deciding what type of account you’re after: instant, notice or fixed & indeed whether you want monthly income from any of those accounts. This may be a decision based upon whether or how much access you need to the capital. Make sure you used your ISA allowance.

Make sure that you don’t deposit the entire £65,000 in one bank or building society as the FSCS compensation limit is restricted to £50,000. Ideally limit the amount to below £50,000 so that the compensation will cover (some) outstanding interest if it comes into play.

In terms of fixed rate bonds expectation is that available rates will decline short term but again there’s no certainty that this will happen. It might be worth your while to have a chat with an IFA to discuss possible alternatives.

.....................................................................................................................

Obviously its a hard one to judge, but are mortgage providers likely to pass on any further cuts to borrowers? My mortgage is up for review and I was wondering whether it would be better to take out a tracker/fixed rate now or continue on variable rate for a while longer? Sharon, London

DB:

This depends upon two factors, your existing mortgage type and the terms of your mortgage/lender. At the moment there is a substantial difference between the Standard Variable Rates (SVR) between the lenders – over 2.50 per cent between the highest & lowest.

With SVRs the borrower has no control on whether or not an SVR change will happen or indeed the extent to which any SVR change will match any change in the bank base rate. Think about whether your lender has a competitive SVR.

Bear in mind that if house prices fall further it may affect the Loan-to-Value percentage that you need for a remortgage. If your LTV is or becomes over the 60 per cent LTV threshold rates charged tend to increase. The general expectation is that tracker margins above the bank base rate may increase slightly but there’s no real way of knowing whether this will in fact materialize. Good luck in your search

.....................................................................................................................

The papers are full of how low interest rates are, yet when applying for a re-mortgage, the rates on offer are nowhere near the current interest rate. I don’t understand. Why is there such a discrepancy between the Bank of England Base Rate and anything you can get from mortgage lenders? Also, why are some tracker lenders putting a ‘collar’ on their deals, below which the rates cannot drop? Thank you, Alec High, Leeds

DB: A few years ago many of the mortgage lenders were chasing volume of lending. Now it’s quality they’re after and the keenest mortgage rates are generally restricted to those who have a high level of equity (typically those that are seeking to borrow no more than 60 per cent of the property value). As the Loan-to-Value percentage increases above that level the mortgage deals available become progressively more expensive.

In essence there’s little appetite amongst lenders to compete because they have a finite amount of money to lend and when they put their head above the parapet by offering the keenest rate available they will quickly lend as much as they want.

Lack of funding and the cost of funding both severely impact on the mortgage rates that they can offer. That said HSBC has announced that it’s looking to do a substantial amount of residential mortgage lending during 2009.

The banks also have to try and offer attractive savings rates as well as operate profitably. The collars on tracker rates have been imposed by some lenders to ’protect their savers’.

.....................................................................................................................

Some people are predicting that the Bank of England may, during the early part of this year, cut rates to close to zero; but what will this mean for those who have savings? With some providers saying they will not pass on any cuts to borrowers, could this mean savers will get some interest paid even if rates do hit zero? Also I have even heard of negative rates being talked about, surely this cannot be a serious consideration - can it? Philip Bowes, Norfolk

DB: I very much doubt that there will be negative rates but we may see balances below a certain amount receiving no interest in some accounts. That said, ”Added value” or ”packaged” current accounts charge a monthly fee so I suppose if you take the fee into account you would be getting a negative return.

Although inflation has fallen slightly it’s virtually impossible to get a real rate of return for taxpayers. There are various things that savers can do but it’s difficult to improve things greatly:

* use your annual ISA allowance;

* if you’ve had the same variable rate savings account for some time it probably won’t be paying as competitive rate as may be available elsewhere, so think about moving your savings elsewhere;

* there are a number of regular monthly savings accounts paying high rates;

* there are a number of current accounts paying high introductory credit rates on balances up to, typically, £2,500.

* if you’re a higher rate taxpayer and have a mortgage as well as a reasonable level of savings it might be worth contemplating an offset mortgage.

.....................................................................................................................

It may be a simple question to answer but if the banks say that they are no longer going to pass any interest rates on to their customers (individuals or businesses), what is the point in the Bank of England reducing them any further?, Jon Redworth

DB: That’s a very interesting question which is the subject of much debate. In normal times a base rate cut is good news for variable rate mortgage holders and first time buyers but not for savers.

These are not normal times, however. The banks and building societies face many challenges at the moment such as:

* They need to rebuild their balance sheet.

* They need to be fair to mortgage holders and to their savers (it’s difficult to be fair to both at the same time).

* There are undoubtedly many reasons that the Monetary Policy Committee has reduced the bank base rate but the primary purpose must be to improve the amount of available liquidity in the economy and confidence amongst the banks.

* Many companies are having great difficulty getting the funds from banks that they need to continue operating & many high street stores are suffering from lack of consumer spending.

With the number of base rate reductions that have been made recently the Treasury is fast running out of ammunition in this direction (they can’t reduce it much further) and there has also been a substantial decline in the value of the pound (sterling) against foreign currencies over the past six months. This will in time provide inflationary pressure.

There have been some calls for the government to make loans available directly to businesses and/or to guarantee bank debt.

....................................................................................................................

I understand one of the reasons for the reduction is to try and ensure people continue to spend. But with so many people on fixed rates would it not be more beneficial to pass a 1 per cent reduction straight through to fixed rate mortgages? Finlay, Suffolk

DB: If you take out a fixed rate mortgage it does what it says and will remain fixed at that rate for the duration of the fixed rate period. Many variable rate mortgage holders will see a reduction in their mortgage interest rate but these may not be as much as the base rate reduction.

Some tracker mortgages, such as those with the Nationwide Building Society for example, have floors and will not reduce as a result of yesterday’s base rate cut.

Standard Variable Rate mortgages should reduce but the extent of any reduction will vary from lender to lender. The people to feel sorry for are the savers and especially those who rely on their savings income to supplement their income. The base rate reduction from 5.00 per cent down to 1.50 per cent over the last few months has been absolutely horrendous news for them.

.....................................................................................................................

David Black’s experience

David joined Defaqto in May 2004 when Defaqto acquired the financial research company of Blay’s Guides Ltd. He has 16 years of banking research and consultancy experience for the majority of which he was a director.

David is Defaqto’s principal consultant for banking and specialises in credit cards, current accounts, equity release, mortgages, savings and unsecured loans. He is a regular commentator in the media in his areas of expertise.

He is ACII, CeMAP and CeRER qualified, as well as holding an Honours degree from Exeter University. He is also a director of a commercial property company.