Impact_of_a_Sharp_Rise_in_Interest_Rates_on_Households

ART B Interest rates can be defined as the rate at which borrowers pay interest on money borrowed from lenders. Interest rates in the United Kingdom are determined in part by the Bank of England base rate. A rise in the Bank of England base rate will lead to a rise in interest rates. In general, high interest rates lead to an increase in the cost of borrowing throughout the economy and also increase the return on money saved in interest bearing accounts. A rise in interest rates would have a significant impact on household spending. High interest rates are likely to affect: 1. The cost of repaying existing debt 2. The cost of obtaining new credit 3. The decision to save. 4. Consumers expectations and confidence. 1)The cost of repaying existing debt: The rate of interest varies when the Bank of England changes base rates. This is especially true for variable rate mortgages and loans where the interest rate changes over time in line with changes to base rates. If there is a large rise in interest rates, the repayments on variable rate mortgages increases significantly. For many households, rising interest rates would mean that funds would have to be diverted away from other forms of spending and redirected towards mortgage repayments. The increased cost of mortgage and loan repayments might impact households with a sole bread winner. In these circumstances, home makers and carers may be forced to go into employment to increase the household income. Households with retired individuals might have to return to employment and those approaching retirement are likely to continue working beyond retirement age. The increased cost of repaying existing borrowing would impact the household balance sheets. There would be a decrease in liquid assets as funds are directed towards growing liabilities like loan and mortgage repayments. 2)The cost of obtaining new credit: Higher interest rates increase the cost of borrowing and make it more difficult to obtain credit. Interest rates have a big impact on a buyers choice of a mortgage product and therefore, the housing market would be significantly affected by a rise in interest rates. Interest rates help determine whether buyers opt for a fixed rate or variable rate mortgage. With a fixed rate mortgage, the interest rate is fixed for a period of up to five years. The borrower is protected from an increase in interest rates and has the advantage of knowing exactly what their mortgage repayments will be for several years to come. This is a favourable option in times when interest rates are low but are predicted to increase. A variable rate mortgage is one where the rate of interest varies in line with the base rate set by the Bank of England. This type of mortgage is beneficial when the base rate is predicted to be low for a long period of time. It would be unwise to take out a variable rate mortgage in times when the base rate is predicted to rise sharply. When interest rates are high, first time buyers experience great difficulty obtaining mortgages. For those that are able to secure funding, the cost of the mortgage would be very high. In anticipation of a rise in interest rates, households intending to buy property would need to proceed quickly in order to obtain the best mortgage deals before the cost of borrowing goes up. The decision to pursue further education is also likely to be affected by a rise in interest rate because the cost of student loans rises in line with the base rate. Prospective students would have to consider the opportunity cost of going to university. Students would increase their human capital by gaining further education but would leave university with large debts and with no guarantee of securing a well paying job after their studies. 3) The decision to save: A large rise in interest rate would have a significant effect on many households' decisions regarding saving. Like 'variable rate' mortgages, interest rates on variable-rate deposit accounts held at banks and building societies change is response to the base rate. High interest rates provide an incentive to save more and spend less. This is especially true for households that are mortgage-free, have fixed-rate mortgages, or are renting. Ideally, these types of households would not be greatly affected by a sharp rise in interest rates. The opportunity to make a good rate of return on savings has an impact on the composition of households. Instead of leaving home to perhaps rent property, young people may decide to continue living at home to save money to buy their own homes. In times when interest rates are high, households are more likely to pay attention to their budget, curb spending and save money if possible. 4) Consumers expectations and confidence. An increase in interest rates would affect consumer confidence. Households are likely to postpone spending on non essential items until expectations improve. They are also less likely to borrow money in the form of credit and store cards. There are many possible outcomes of a sharp rise in interest rates on households. The effects of a rise in base rate depends on the households composition, level of indebtedness and future aspirations. BIBLIOGRAPHY: Callaghan,G., Fribbance, I., and Higginson, M. (eds) (2006) Personal Finance, Chichester, John Wiley/The Open University. Fribbance, I and Upton M(2006) 'Housing and the financial balance sheet', in Callaghan,G., Fribbance, I., and Higginson, M. (eds) (2006) Personal Finance, Chichester, John Wiley/The Open University. Fribbance, I. (2006) 'Insurance and life events', in Callaghan,G., Fribbance, I., and Higginson, M. (eds) (2006) Personal Finance, Chichester, John Wiley/The Open University. Higginson M (2006) ' Expenditure and Budgeting', in Callaghan,G., Fribbance, I., and Higginson, M. (eds) (2006) Personal Finance, Chichester, John Wiley/The Open University. Lowe J(2006) 'Pensions', in Callaghan,G., Fribbance, I., and Higginson, M. (eds) (2006) Personal Finance, Chichester, John Wiley/The Open University. Upton M(2006) 'Debt', in Callaghan,G., Fribbance, I., and Higginson, M. (eds) (2006) Personal Finance, Chichester, John Wiley/The Open University.