What higher interest rates means for your finances

The Bank of England (BoE) has doubled UK interest rates from 0.25% to 0.5% as it looks to combat rising inflation. The move marks the first back-to-back rate hike since 2004.

In December, inflation climbed to 5.4%, the highest rate since the early 1990s. This was up from a decade-high of 5.1% in November, and more than double the Bank’s 2% target.

As the Monetary Policy Committee (MPC) looks to keep a lid on inflation and alleviate the cost-of-living crisis, what does this hike now mean for your finances:

Mortgages

British households are bracing for an imminent rate hike, according to the latest representative survey of 1,500 UK households compiled by IHS Markit.

Nearly half (49%) of UK households surveyed expect interest rates to rise in the next three months, the highest proportion since data collection began in July 2013, while just 6% of those surveyed in January predict a cut to interest rates at some time, down from 7% in December.

Higher interest rates make borrowing more expensive. Housebuilders have been on the back foot in recent months amid concerns that a succession of rate rises could lead to a cooling of the hot property market.

Borrowers on variable rate mortgages can expect the rise in interest rates to be passed on swiftly, and those who are remortgaging to a new fixed rate will feel the burden of the changes too.

Read more: Bank of England increases interest rates to 0.5% amid rising inflation

The first of the rate rises came hot on the heels of the last hike, and have been feeding through into mortgage deals ever since.

“The Bank’s aim is to raise rates slowly and steadily, so we don’t get any nasty surprises,” Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, said.

“However, this doesn’t really have the same impact if we’ve fixed our mortgages for years, because we’ll face the consequences of all these rises at once.”

For example, if someone is currently paying 1% on a £200,000 ($272.516) mortgage over 25 years remortgaged at the end of the fixed period to a new deal costing 2%, it could push up their monthly costs by £94.

Watch: Will interest rates stay low forever?

Prices

Household services, which includes gas and electricity, were among the biggest contributors to the cost of living rise last month. The price of electricity is up 18.8% in a year, and gas is up 28.8%.

In addition to this, price rises are being most keenly felt in transport and fuel, as well as energy, which are areas where expenditure is unavoidable. This constitutes a bigger slice of budgets of those on lower incomes.

Higher interest rates will not have much effect on energy and petrol prices as these are driven by global supply problems.

Read more: Energy price cap: Gas and electric bills to rise as Ofgem brings announcement forward

Savings

Higher interest rates mean a higher return on your money if you have a variable rate savings account.

“The last rise helped the banks boost their margins, so they’re in a slightly different position now,” Coles said.

UK banking stocks have been on the rise since December thanks to the prospect of their loan businesses becoming more lucrative.

The more rises that take place, the more likely it is that rates tick up, even among the most reluctant institutions.

"Although, very few will do so in full, and most will take their time about it, so the best deals will be available to those who are prepared to shop around," Coles said.

She added: “You may be tempted to hold on for a better rate instead of fixing. But you have to decide what you’re waiting for, and when you’ll stop waiting and fix.

"Will it be enough for you if the Bank of England raises rates to 1%, or will you be tempted to hold out in the hope of 1.25% at the end of the year? If so, how much interest will you have missed out on in the interim?”

However, there is no guarantee that a rise would be passed onto all savers. The hike in December (from 0.1% to 0.25%) did not persuade high street retailers to budge on easy access accounts.

Read more: UK banks launch 95% mortgages: Everything you need to know

Tax

Companies reliant on big borrowing to fuel their growth plans have been highly sensitive to expectations that the era of cheap money is coming to an end.

High interest rates mean that borrowing will become more expensive, not only for consumers but also for the government.

One side-effect of the Bank of England hike is that the UK government may now harden opposition to pressure to shelve the National Insurance hike.

National Insurance is going up by 1.25 percentage points in April to 13.25%, adding hundreds to workers' tax bills.

Watch: Raising National Insurance in April is ‘wrong thing to do’, says Starmer