What to be aware of following the interest rate cut

The Bank of England's Monetary Policy Committee (MPC) is usually seen as a quite predictable as it increases or reduces interest rates by a small amount incrementally, generally a quarter of a point either way. But recently we have seen a different side to it, as last month it cut rates by a massive 150 basis points a full 24 hours earlier than expected.

This came after many economists had believed we would only see half a point cut, although some thought they were being rather optimistic by considering a full percentage point cut. You can imagine that the decision to drop rates to 3% came as a big surprise to all.

This is a stark reminder that the economy is in more trouble than we may have perceived. The International Monetary Fund has warned of predictions that a recession in the UK could be more severe than in any other industrialised nation.

One of the big reasons for such a significant cut was to try to encourage consumers to spend again after they became thrifty due to an increase in living costs and a drop in financial confidence. This lack in spending alone can be enough to cause a recession as the economy is pushed off balance.

The idea is that as mortgage rates fall, people will have more monthly disposable income which in theory can then be put back into the economy. However, this strategy is by no means 'full-proof', as there are no guarantees that your mortgage rates will be reduced.

Several of the main lenders have already announced rate cuts, passing on the full 1.5% on standard variable rates (SVR). These include  Halifax, Abbey, Royal Bank of Scotland, Nationwide and Cheltenham & Gloucester. However, 32 lenders failed to announce cuts to their SVR after last month's half-point cut and just 24 lenders passed on the full cut to their SVR.

Something that took borrowers by surprise was that several lenders actually increased rates on many deals for new customers. Abbey increased its tracker rates by half a percentage point 48 hours before the MPC announced the new cut and a number of other major lenders pulled back their tracker products all together.

To add to the concerns, savers now face the problem of the value of their money potentially dropping due to inflation being higher than the rates on many savings accounts. This adds to the concerns relating to a recession, as even with lower mortgage repayments, people may not want to be spending when their savings are actually being eroded.

This has left us in an unpredictable time, but whether you're a saver or a borrower, or even both, there are some measures you can take to keep yourself aware of what this interest rate cut means to you.

Do not presume that just because you have a variable rate mortgage, your mortgage repayments will go down.

Tracker mortgages are designed to follow suit with Bank rates, so they will fall. However, lenders can do as they please with their SVRs. Lenders do generally pass rate changes onto their SVRs, but as conditions have worsened in the current climate, there are fears that many will choose not to.

As expected, the demand for variable rate mortgages rises as interest rates fall, as borrowers want to benefit from lower mortgage payments. However, the discounted deals are set in line with lender's SVR, as opposed to the Bank rate, so reduced payments cannot be guaranteed as interest rates fall.

As tracker mortgages are linked to the Bank rate they can seem the obvious option. However, some do come with have a catch, for instance several lenders include 'collars' which allows them to hold back on reductions in rates if Bank rate drops below a certain level.

In normal circumstances borrowers wouldn't be affected by collars but as Bank rate has fallen to its lowest point in 53 years it is very possible that some may not see the benefits with more rate cuts expected.

As interest rates have fallen from 5% to 3% in the last 2 months, you may wish to rule out fixed rate mortgages, but this avenue should be explored.

The reason for this is that many people would rather be sure of exactly what their monthly payments are to avoid unwelcome surprises. It is also important to remember that interest rates have been slashed recently and sooner or later reach a low. The idea of fixing your rate means that you will be protected against rises in interest rates in the future, providing you with protection against a turn in the economic climate.

The standard SVR floats at around 7%, which is substantially higher than the current Bank rate. Even with rates on new mortgage products set above Bank rate, it is still possible to benefit from re-mortgaging.

As a result of the mortgage crisis and a slowdown in the property market lenders have become more selective over who they lend to, so re-mortgaging may not an option for you.  However, if you have more than 25% equity in your home it is very likely that you could save money by re-mortgaging. If you find you have less than that, it is always worth checking as you may still qualify for a re-mortgage package.

Published by Sam Gooch