What are interest rates and how do they affect me?

Interest rates affect all of us, whether you realise it or not. 

What are interest rates? 

An interest rate is a percentage charged on an amount borrowed. 

Think of it as a cost paid for the privilege of borrowing money, and a reward earned for saving money. 

As a simple example, you borrow £1000 from a bank at a 3% interest rate. You give the bank back £1039. The difference of £30 (3% of 1000) is the cost of borrowing.

If you are a saver, the bank will pay you an interest on the money in your bank account. The interest fee goes to you and is added to your account. 

High interest rates vs lower interest rates

When you take out a loan like a mortgage, you have to pay back the loan amount plus the interest rate. So as a borrower, you want a low interest rate. 

When you are a saver, you want to find a high interest rate to maximise your savings account.

Note: Interest rates are different to APR.

How do interest rates affect my personal finances? 

You may have heard of the Bank Rate, or the ‘Bank of England Base Rate’. This is the interest rate the Bank of England charges high street banks This is the interest rate the Bank of England charges high street banks (Lloyds, RBS, HSBC, TSB, Barclays, Santander, etc) to borrow money. When the Bank rate is low, high street banks pass on the savings to their customers like you and me. 

The current rate is 0.1%. In a historic context, this is very low. This is to encourage borrowing.

As the average loan amount can be very high, even a small increase to the Bank Rate can have a big impact on you. If they go up, lenders may want to charge more interest from borrowers. 

If you are thinking of taking out a mortgage loan or re-mortgaging, you can use a mortgage calculator to see how mortgage interest rates changes can impact your monthly payments. You can also use an app like Money Dashboard to see if such payments are realistic, and what changes you can make to better pay that bill. 

Of course, current low interest rates mean savers are not seeing big rewards. This means adding money into savings accounts and ISAs becomes less attractive. 

Notably, credit cards rarely have much connection to the bank rate. They can have very high interest rates – more than 20%, on unpaid debt. So pay close attention to the fine print and search for the lowest interest rates you can. 

What to consider during interest rates highs & lows 

Despite the Bank Rate, when shopping for a loan you will find that interest rates vary. 

If you are borrowing, this variation is because the lender is considering other factors – most importantly the risk of you not paying them back.  (Lower risk = lower interest rate.) You may want to improve your credit score to help get a better offer.

If you are saving or lending, you will want to shop around for the highest interest savings account. To get started, take a look at services like Marcus from Goldman Sachs, which pays higher interest rates on savings than most bank accounts, and at Moneybox, an app that helps you save and pays a higher interest on the accumulated savings.

Disclaimer

All content is for informational purposes only and is the opinion of the author. Nothing on this website should be interpreted as "advice". Money Dashboard Ltd make no representations as to the accuracy, completeness, suitability or validity of any information on this site and will not be liable for any errors or omissions or any damages arising from its display or use.

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