WHAT DO HIGHER INTEREST RATES MEAN FOR YOUR PERSONAL FINANCES?

Interest rates and inflation are headline news. But what does it mean for your personal finances?

MUVADO’s quick summary is:

  • Your cost of debt is likely to increase:
    • It’s even more important to pay off your credit cards each month.
    • Manage your mortgage repayments as a priority.
  • Your return on cash and bonds will increase:
    • Find the best cash rates.
    • Stay patiently invested with your bonds to receive higher returns.
  • Inflation should decrease:
    • The cost of your monthly food shop should stop spiralling.
    • Energy and fuel prices should stabilise.

Background

Inflation (the change to price of goods and services) has been rampaging upwards due to the Ukraine war and the bounce back from Covid. To manage inflation, interest rates have increased, aiming to reduce overall consumer demand and bring inflation down.

Interest rates are now at levels not seen for over 15 years. We’ve been used to a low interest rate world and some of us will have never experienced meaningful interest rates as adults.

When there’s a lot of noise (and news), it’s important to take a step back and focus on what you can control and what’s important to you.

Mortgages

Higher interest rates mean your mortgage payment is probably going to increase.

If you’re on a tracker mortgage or have a fixed term deal coming up shortly, you face a tricky decision. Should you move to the certainty and security of a longer term fixed deal, or take a shorter fixed term in the hope that interest rates come down? Your decision will depend on your attitude to risk for financial decisions and your current circumstances and objectives.

If you have a mortgage within a fixed interest rate period, you can prepare for a higher interest rate by building a cash buffer. Imagine your mortgage interest rate has gone up today and start managing your monthly income and expenditure accordingly. Move the difference between your current mortgage repayment and your future estimated repayment into cash savings or if you will not need the money for at least 5 years, get it invested.

If you cannot afford the increase to your mortgage repayment, you will have to consider moving to interest-only, or extending your mortgage term to bring down the monthly repayments.

Cash savings

You can now get a risk-free return on your cash. It’s been unusual to see transaction of interest in pounds and not only pence!

Interest rates on cash savings have increased substantially you may want to look at my previous blog: 3 ways to hold cash savings for guidance on where to hold your cash.

Note – although cash savings have increased, the interest rates remain substantially below inflation and your cash savings are losing purchasing power. For money not needed within the next 5 years, you should consider investing.

Expenditure

The aim of higher interest rates is to reduce demand and in turn, reduce inflation. The cost of your food shop and filling up your car might not decrease, but it should stop increasing so quickly.

Making sure you spend your money on the things you value most and noting where your money is going is a good starting point to manage your expenditure.

Summary

Seeing interest costs increase as part of our mortgage isn’t nice. It feels like wasted money.

It’s important to note over the past decade we’ve been fortunate there has been a low cost of borrowing. There are also reasons to be positive about the new higher interest rate environment:

  • UK wages increased by an average of 7.2% to June 2023. The highest for 15 years.
  • Cash interest rates with NS&I have increased over 15 times. From a lowly 0.15% in November 2020 to 2.85% now.
  • Investment bonds should provide higher investment returns over the long-term.

Disclaimers

Remember that when investing your capital is at risk. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.