Interest rates rise to 3.5% - we explain what it means for your money

The Bank of England has increased rates by 0.5 percentage points. We explain what this means for your mortgage, savings and loans

Hands Stacking Percentage Signs on Wood Toy Block
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The Bank of England has raised interest rates from 3% to 3.5%, the highest level since 2008.

The sharp increase is the ninth interest rate rise in a row, and means rates have soared from 0.1% to 3.5% in less than a year.

It comes a day after news from the Office of National Statistics that inflation had eased to 10.7%. The move to raise rates is an attempt to slow inflation, which is more than five times the central bank’s 2% target.

But decision-makers on the Monetary Policy Committee were not unanimous, with a three-way split: six voted in favour of a 0.5 percentage point rise while one person wanted a bigger increase and two others wanted a pause.

The decision will pile more pressure on millions of households already struggling with the cost of living crisis. This includes homeowners with variable-rate mortgages or those with fixed rates about to expire, plus those who have borrowed money via credit cards or personal loans. 

Alice Haine, personal finance analyst at Bestinvest (opens in new tab), says: “An interest rise less than 10 days before Christmas might feel like a blow for struggling households, but the 50-percentage point hike signals a slower pace of monetary tightening following the 75bps increase last month - the biggest single increase since 1989 – offering a glimmer of hope that the mood is shifting. 

“Increasing interest rates when the economy is on the brink of a recession might not be typical behaviour for a central bank, but the Bank of England is intent on taming double-digit inflation and bringing it closer to its target of 2%. Inflation may have passed its peak after dropping to 10.7% in the 12 months to November from a 41-year high of 11.1% in October – with the BoE expecting it to fall rapidly over the first quarter of 2023.”

We explain how the rate hike will impact your household finances, whether you have a mortgage, savings, borrowing or pension.

Impact of rising interest on mortgages

Around 2m homeowners are on a variable-rate mortgage, such as a tracker mortgage, or a standard variable rate (SVR). 

Tracker mortgages will automatically go up as a result of today’s interest rate rise and increase homeowner’s monthly mortgage payments while those on SVRs should look out for their lender deciding whether to increase their rates and giving them notice before they do so.

An SVR is the highest rate from a mortgage lender and is what you’ll fall onto once your fixed-rate deal is up. It means you generally have a window of opportunity to protect your finances by locking into a fixed-rate deal. But homeowners should brace themselves for steep fixed-rate products: the typical two-year fixed deal is 5.84% and a typical five-year is now 5.66%, as of 14 December, according to data analyst Moneyfacts.

Myron Jobson, senior personal finance analyst, interactive investor, adds: “A 0.5% rate rise is not insignificant. It is the second biggest base rate hike since February 1995. For those on a tracker mortgage deal, it could mean paying hundreds of pounds more a month.

“Cheap mortgages have gone the way of the dodo following a spat of rate rises, and borrowers coming off a fixed mortgage are set to be in for a nasty shock as the cost of a new fixed rate deal is likely to be much higher than they were perhaps anticipating. This could not come at a worse time amid a cost-of-living squeeze on household budgets.

“The dilemma facing many homeowners approaching or at the end of a fixed rate deal is whether to lock themselves into a higher rate mortgage over a short or long term now or wait and see if mortgage rates will. Doing the latter and falling onto the standard variable rate could also be an expensive option as the average rate has risen to its highest level in over a decade.

Impact of rising interest rates on savings

Savers may think they can look forward to higher returns on their cash. However, banks and building societies do not have to raise their rates immediately - and even then it could be a much smaller uplift than the full 0.5 points.

“Higher interest rates do not always translate to higher savings rates,” sas Jobson. “It could take months for the increase in interest rates to trickle through to savers – if at all. Put simply, you may get a better savings rate in the near future – but there are no guarantees. The amount you are looking to save could guide your decision. An uptick in savings rates could mean the difference between pennies and hundreds of pounds depending on how much you have to save.”

The best savings account on the market is First Direct Regular Saver that pays 7% on savings up to £3,600, but you do need its current account to benefit. 

See our article on the best savings rates for more.

Impact of rising interest rates on borrowing

Today’s interest rate increase means the cost of borrowing on a credit card or via a personal loan may also rise. 

See our article on the best personal loans for more.

Katie Binns

Katie is staff writer at The Money Edit. She was the former staff writer at The Times and The Sunday Times. Her experience includes writing about personal finance, culture, travel and interviews celebrities.  Her investigative work on financial abuse resulted in a number of mortgage prisoners being set free - and a nomination for the Best Personal Finance Story of the Year in the Headlinemoney awards 2021.