Which way will you blow if the base rate rises?

As the Bank of England deliberates, Melanie Bien helps borrowers and savers make the right decision
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The Independent Online

These are worrying times for homeowners and for any-one who has over-stretched themselves on their credit card or personal loans, as speculation mounts that interest rates are set to rise.

The minutes from the last meeting of the Bank of England Monetary Policy Committee (MPC), where the base rate was kept on hold, show that four of the nine members voted for a rise from 3.5 to 3.75 per cent. As a result, most commentators expect to see an increase in the next 12 months. Some are even going so far as to predict one before the end of the year.

According to a survey from Legal & General of 10 City investment banks, the average prediction for the base rate by the end of the year is 4.13 per cent. Goldman Sachs is predicting the largest rise (to 4.8 per cent) while HSBC Securities thinks there will be a fall instead (to 3 per cent).

If rates do rise, savers will finally have something to cheer about, after enduring poor returns on their investments for many months. Justin Modray at independent financial adviser (IFA) Bestinvest points out that medium-term fixed-rate savings products are already looking more attractive.

Capital One Bank is offering a five-year fixed-rate bond at 5.4 per cent gross per annum on a minimum investment of £5,000. The "best buy" equivalent a month ago was Julian Hodge's five-year bond paying 4.9 per cent.

Last week Portman building society also launched a fixed-rate bond, paying 5 per cent, although the investment term is one year rather than five. The minimum investment is £2,500.

"Investing in fixed rates is obviously a gamble," says Mr Modray, "but with banks and building societies offering fixed-rate bonds paying 1.5 per cent or more gross above the current base rate, interest rates would have to rise significantly for investors to lose out."

While savers are already benefiting from the prospect of a rise in interest rates, the situation isn't so rosy for borrowers. Research from Clear Cut Mortgages shows that just one in six homeowners is on a fixed-rate deal, so a rate rise would affect a large majority.

But this is only going to be a problem if you believe rates are going to rise significantly - and soon. Ray Boulger, senior technical manager at mortgage broker Charcol, is not convinced that this is the case; he predicts rates will still be at 3.5 per cent come the end of the year.

"The City has a consistently bad record for predicting by how much rates will rise and how quickly," he warns. "There is a likelihood that there will be a rate increase but it's a mistake to assume it will happen next month. The MPC is going to have to reassess the situation on the basis of statistics out in the last month, which were fairly static."

Whatever the future holds, homeowners should make sure their mortgage deal remains competitive.

If you are already on a fixed rate, you don't need to take any action, but if you are about to remortgage or are in the process of buying your first home, you will have to decide whether to opt for a fixed-rate deal.

Britannia building society is offering the best five-year fix, at 4.64 per cent, while Abbey offers 4.69 per cent. Mr Boulger says that, compared with the best two-year tracker and discounted deals, which are currently around 3.25 per cent, these fixed rates aren't particularly competitive.

"With one of these fixed-rate deals, you are paying a significant premium if rates don't go up," he adds. "But if people are really nervous about rate rises, they should perhaps opt for a fixed rate."

He argues that a better course of action is to take out a flexible deal, enabling you to over- and underpay. Get the lender to calculate how much it would cost you if the base rate rose to 5 or 6 per cent, then pay this amount every month. That way, if rates do rise, you'll have a cushion as you will have overpaid on your mortgage for what could be several months. And if they don't rise, you'll simply pay your mortgage off more quickly.

If you are considering remortgaging before any increase in the base rate, check with your lender first to see whether you will have to pay a penalty for doing so. If so, it may not be worth your while.

And if you still figure it will save you money to remortgage, ensure you shop around to get the best deal, preferably using an independent broker.

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