We look at the implications for mortgages, savings and annuities of news that interest rates will remain at a record low
Interest rates look set to remain at record lows for another three years after the Bank of England governor Mark Carney's announced that they will be linked to the employment rate.
In a major shift in monetary policy, the new governor said rates will not rise until the employment rate sinks to 7%, which is not expected to happen until 2016. The so-called "forward guidance" strategy is aimed at giving households and businesses clarity on the future of interest rates, which will remain low to bolster economic recovery.
But given that the Bank of England base rate has sat at just 0.5% since it was cut in March 2009, and is now likely to remain at rock bottom for a year longer than anticipated, what does this mean for your finances?
I have a variable rate mortgage. How will this affect me?
The announcement will reassure overstretched borrowers fearful of potential rate rises. However, only those on tracker rate mortgages, where the rate they pay is linked to the base rate, and on standard variable rates (SVRs) explicitly linked to the base rate can relax. Most lenders reserve the right to change their SVR when they want, even if interest rates don't change.
Those on a variable rate, particularly if their loan is linked to their lender's standard variable rate, are being urged by brokers to consider slashing their monthly repayments by locking into a fixed deal. However, brokers emphasise that rates could have further to fall, so borrowers might want to bide their time.
Jonathan Harris, director of mortgage broker Anderson Harris, says: "We expect fixed-rate mortgages to fall even further on the back of this announcement. They may already be at historic lows but if lenders are to convince borrowers to opt for a fix when interest rates are highly unlikely to rise, then pricing needs to be attractive."
He adds that borrowers who prefer the certainty of a fixed rate should consider a five-year fixed-rate deal, to provide security beyond the three-year mark when there could be an uptick in rates.
Is a fixed-rate mortgage a good idea if rates won't change?
A longer-term fixed rate is likely to look more attractive than a two-year fixed-rate deal after Carney's words, and rates on five-year deals are very competitive. Norwich and Peterborough building society is currently offering a five-year fixed mortgage deal at 65% LTV with a rate of 2.59% and a low £295 fee. This comes with free valuation for all borrowers, and remortgage customers get free legal fees while house purchase customers get a £200 rebate.
You can get a two-year fixed-rate deal for as little as 1.49% from HSBC but the fee is steep at £1,999 – and when it comes to an end, the deals you can switch to could be more expensive.
I am a saver. Will things change?
Savings rates have plummeted in recent years, made worse by the introduction of the Funding for Lending scheme a year ago which gave lenders access to cheap finance to help borrowers, but made them less reliant on attracting savers' deposits.
It is already almost impossible to find savings rates that beat inflation, and Danny Cox of IFA Hargreaves Lansdown suggests things are not likely to improve soon.
"Those most negatively affected by Mark Carney's proactive stance will be savers. The bank will likely tolerate above-target inflation over the next few years, meaning real interest rates will remain negative," he says. "Interest rates on cash deposits aren't going to rise anytime soon and certainly not significantly for three years it seems." Cox says that when Funding for Lending ends – in 2015 – things could start to get better.
Rachel Springall, finance expert at Moneyfacts, says: "As the savings market remains volatile it may be wise to opt for an easy access Isa to move money if needed, and benefit from tax-free interest. The best rates on fixed rate savings deals are particularly long term and may be too much of a commitment for savers who don't want to lock in their cash."
What does it mean for my pension?
If you are about to retire you will probably use your fund to buy an annuity. Forward guidance has made what will happen to annuity rates clearer – but unfortunately it has made it clear that they are unlikely to improve for three years.
Tom McPhail, head of pensions research at Hargreaves Lansdown, says: "For those with a small pension pot or who need certainty, it now makes sense to get on with buying an annuity; for those with larger pension pots or who can tolerate some investment risk, it makes sense to park the idea of buying an annuity for a few years and look to income drawdown instead."