Interest rate rises to 3.5% – what it means for annuities and mortgages

Today, the Bank of England (BOE) raised the base interest rate to 3.5% from 3% in November. This shows that while inflation might have slowed in November to 10.7%, inflation fears are still trumping a recession at the BoE.

The latest rate rise is likely to make life more difficult if your borrowing is linked to the base rate, but the impact on fixed-rate mortgages is more complicated. We could well see the weird phenomenon of base rates going up, while mortgage rates drop. On the other hand, annuity rates will likely benefit.

Potential for better annuity rates

The prospect of another rate increase could spell good news for an annuity market that’s risen rapidly over the course of the year. While rates have declined from the dizzy heights achieved in the immediate aftermath of the mini-budget, they remain the highest seen in over a decade.

Our annuity comparison tool shows that at the time of writing a 65-year-old with a £100,000 pension could get themselves an income of £7,036 a year (rates are based on a £100,000 single life level annuity with a five-year guarantee period built in, and paid monthly in advance). This is a huge improvement on the £5,033 they could’ve got at the same point last year.

Annuity rates are affected by, amongst other things, the yields on long-term gilts as well as interest rates. It’s likely an interest rate increase will boost rates in the coming weeks, but it’s not a guarantee.

Annuities have fallen out of favour with the advent of pension freedoms and choice. But for anyone with a need for some level of guaranteed income in retirement, they should be considered. These higher annuity rates should encourage people to take a closer look.

It’s important to shop around though. That’s because the incomes offered by different providers can vary, so getting a comparison from across the market will help you get the highest income.

Mixed impact on mortgage deals

For homeowners on tracker mortgages or a standard variable rate (SVR), the pain is likely to be immediate. There’s every chance the ranks of these homeowners have been swelled in recent months, as borrowers reached the end of their fixed-rate deal and decided to let it roll over onto the SVR while they waited for fixed rates to come down.

The average SVR was 5.86% in November, so if the full rise is passed on, rates will be well over 6%. It’s going to make life incredibly difficult for those who rolled over from a deal at 2% or 3%. It might even encourage them back into the certainty of a fixed-rate deal again.

For those looking for a fixed-rate mortgage, there’s every chance that it’s already been priced into the market. So instead of encouraging rate hikes, those fixed-rate deals could continue on their current downwards trajectory.

Both the two-year and five-year fixed rate average have fallen below 6%, and the best deals are offering around 5%.

The market is being driven by rate expectations further down the track, which have fallen dramatically since the surge that was powered by the mini-budget in September. As a result, the market now expects the base rate to peak at somewhere around 4.5%, before falling back as the recession takes hold. It means it doesn’t need to price fixed rates so high.

Mortgage rates could fall further from here, but it’s not guaranteed, and there’s no clear picture of how long any more falls will take. Some of those sitting on an expensive SVR might decide to wait for the New Year, while others will be tempted to make the move, and cut their costs today.

If you’re on an SVR of 5.86%, with a £200,000 repayment mortgage over 25 years, assuming any rate rise is factored in, it would cost:

Source: Moneyhelper mortgage calculator.

This article isn’t personal advice. If you’re at all unsure, seek advice.

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