What is the real cost of 0.5pc Bank Rate?
Three years on, savers are paying a heavy price to subsidise cheap borrowing.
7:00AM GMT 25 Feb 2012
Savers have lost more than £5,000 since the Bank of England reduced interest rates to a historic low of 0.5pc three years ago – but borrowers have cashed in.
While few savers will be celebrating the anniversary of this decision next week, mortgage borrowers will be toasting a windfall of almost £40,000, which is what the average householder has saved in interest charges over this period.
The unprecedented cut in interest rates was designed to protect an enfeebled economy from outright collapse, but the effect on families up and down the country has been enormous. Research for The Telegraph shows the extent to which families have gained or lost out. Pensioners are among those who have suffered the most; many depend on the income they receive from savings, so they have seen their standard of living fall – a decline made worse by high levels of inflation. Conversely, it is younger people, who typically have larger mortgages and other debts, that have benefited from lower borrowing costs.
Here we look in detail at how the Bank of England's extreme measures have affected our fortunes.
Savers
The Bank started seriously cutting interest rates in response to the growing credit crisis in December 2007. In the three years before this, the rate paid to savers with instant access accounts averaged 3.15pc, according to Defaqto, the data analyst. But over the past three years the average rate has been just 0.94pc.
As a result a saver with £20,000 in one of these accounts would have seen the interest they receive reduced by 70pc. In pounds and pence this means the interest has fallen from £1,950 to just £570 before tax – so they now get £1,380 less. For a basic-rate taxpayer, this means his income cut from £1,560 to £456, a fall of £1,104.
It's a similar story for cash Isas. The average rate on an instant access Isa in normal times was 4.85pc, Defaqto said, compared with only 1.52pc over the past three years. Assuming that savers had amassed £50,000 from successive years' Isa allowances, their income would have fallen from £7,635 to £2,315 – a fall of £5,320.
However, those who have shopped around and moved their savings regularly could have avoided much of this income loss. Over the past three years the average "best-buy" instant access account has paid 3.06pc, Defaqto found. As a result, anyone who switched from an average account to a best buy when the Bank cut rates to 0.5pc – switching again where necessary – would have seen their income fall by just £108 from £1,950 to £1,892 a year.
The average rate on a best-buy instant access Isa has been 3.12pc since March 2009. So a saver who took £50,000 out of an average product at that point and ensured it was always in a best-buy Isa thereafter would have seen their income fall by £2,805 from £7,635 to £4,830.
If you have left your savings in an account paying next to nothing, it's not too late to take action – in fact, economists don't expect Bank Rate to rise until late next year at the earliest. The best rate on the market for instant access accounts is currently 3.1pc on Santander's eSaver Issue 4, Defaqto said. Better rates are available if you tie up your money – such as 3.55pc for one year (from Aldermore), 3.85pc for two years (Vanquis Bank) and 4.2pc for four years (from BM Savings). Rates on equivalent Isas are often slightly lower.
David Black of Defaqto said: "There's a wide variation in the interest rates available even for the same sort of account – the rates paid by easy access accounts range from as little as 0.01pc up to 3.1pc. This shows how important it is to shop around for the best deal. If you've had an account for a while, the chances are you can get a better deal elsewhere."
Borrowers
Where savers have lost, mortgage borrowers gained. In the three years to December 2007 the average lifetime tracker mortgage charged Bank Rate plus 0.7pc, according to SPF Private Clients, the mortgage broker, so the rate that you actually paid at that time was 6.2pc. But since Bank Rate fell to 0.5pc the interest rate paid has been just 1.2pc.
As a result, monthly repayments on the average £250,000 lifetime tracker mortgage have fallen from £1,292 in the "normal" years to £250 now (on an interest-only basis). Total payments over three years have fallen from £46,512 to £9,000, saving the average borrower £37,512.
Two-year fixed-rate deals were also popular before the credit crisis. Someone who took out one of these loans two years before Bank Rate fell to 0.5pc would typically have paid an interest rate of 5.18pc, SPF said, taking a loan from Nationwide as an example. Monthly repayments at that rate would have been £1,079 (again interest-only).
After the introductory period on these mortgages has expired, the rate typically reverts to the lender's standard variable rate (SVR). A borrower who took out Nationwide's two-year fix in March 2007 might have expected to pay 7.5pc when the two years were up, as that was the SVR at the time. Instead, the SVR after Bank Rate fell to 0.5pc in March 2009 was just 2.5pc. This borrower's monthly payments would have fallen from £1,563 to £521, saving them £37,512 over the past three years.
But many home owners chose instead to maintain their payments when interest rates fell. This has the effect of paying off an extra slice of capital every month, cutting the overall interest bill and allowing the mortgage to be paid off in full sooner.
The average tracker mortgage customer with a £250,000 loan would have saved £1,978 in interest over the past three years if they had maintained payments at the level of December 2007, while their mortgage term would have been cut by almost 10 years.
Many people have both savings and a mortgage, of course. As we have seen, their savings will often have paid very little interest over the past three years. A better use for the money can be to reduce the mortgage balance.
If a home owner with a £250,000 mortgage on a typical lifetime tracker charging 3.56pc had used their savings to make a £20,000 lump payment on their home loan in March 2009, they would have saved £2,886 in interest so far and would be in line to shave two years and nine months off their mortgage term, according to HSBC. The figure for a £50,000 payment is £6,262.
Mark Harris of SPF said: "While interest rates are at record lows, not all borrowers are taking advantage. If you are on your lender's SVR and it's 3pc or more, you might want to consider remortgaging. There are some very cheap fixed rates at less than 4pc for five years, or two-year trackers starting at less than 2pc for those with enough equity in their property."
Peter Dockar, the head of mortgages at HSBC, said: "By paying down their mortgage now, borrowers are able to reduce the impact of higher monthly repayments if interest rates rise. It will also build up equity in their properties, giving them access to better deals if they need to remortgage in future."
