Protect your cash from an interest rate rise

by Emma Lunn on 03 January 2012  |  3 comments
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Will interest rates rise in 2012? Maybe 2013? No one can say for sure, but we need to be ready when rates do rise.

Rate rise forecasts have been pushed back time and time again. There was a time when it looked like a rise was likely some time in 2011 but 2011 has now been and gone and still the base rate remains at 0.5%.

A few economists think we could see the first rise in 2012 while others say 2013 is more probable. A handful of pundits think we’ll be enjoying low interest rates until 2015.

But it pays to err on the side of caution and be ready for a rise when it happens...

Fix your mortgage

Borrowers on variable or tracker rate mortgages have been enjoying lower payments ever since the base rate started dropping back in 2009.

However, once you’ve enjoyed low monthly payments for so long it’s easy to get carried away and start thinking rates will always be low.

So, have a think about whether you could still afford your mortgage if rates started to rise. If it would be a struggle it might be wise to lock into a fixed rate deal now, so that you can be sure of future repayments.

As rates are more likely to rise from, say, 2014 onwards rather than in the next two years, it’s probably better to opt for a five-year fix rather than a two-year deal.

To check out the best mortgages at the moment, be sure to have a go on the lovemoney.com mortgage tool, which will help you compare deals from all across the market.

Overpay on your mortgage

Another good way to get ready for a rate rise is to overpay on your mortgage. For example, if you’re paying 2% calculate what your repayments would be if the rate increased to 3% and start overpaying the extra.

However, before you start overpaying you’ll need to check with your mortgage lender if it’s permitted. Some will charge you early redemption charges, while others will limit how much you can overpay each month.

Insurance

Some mortgage holders on variable deals won’t have the option to switch to a fixed rate due to a lack of equity in their home which will mean they’re not eligible for the best deals. In other circumstances remortgaging will be expensive due to the upfront fees involved.

However, there is another way homeowners can protect themselves from rate rises: insurance. MarketGuard’s Rate Guard product works a bit like a fixed-rate mortgage, capping your payments so that if interest rates shoot up, the policy starts paying out automatically.

However, like all insurance you’re paying for something that may never happen. And it’s not cheap either. Protecting a £150,000 mortgage for two years, with an 0.5% excess (meaning the insurance only kicks in when rates have risen by more than 0.5%) would cost you £30.82 a month or £782.68 a year.

Pay down debts

If you’ve got credit cards or other debts then now’s the time to try and pay them off. While credit card and personal loan rates haven’t decreased as much as the base rate has, you can bet your bottom dollar that credit card companies would use a rising base rate as an excuse to whack up APRs.

So, use any spare cash you have to pay off as many of your debts as possible. Switching an existing credit card balance to a 0% balance transfer card will help you pay off debts quicker as 100% of your payments will go towards paying off the capital rather than on interest payments.

Save

Upping your savings can be seen as a type of “self-insurance”, as if rates rise you’ll have some cash in place to use for the higher payments. And if rates don’t rise, then you’ll still have the money.

It’s important to make sure you’re getting the best rate possible on your savings. Generally, if rates are low it’s not a good time to lock into a long-term fixed rate savings plan. This is because if rates do rise then savings rates should generally improve and you could miss out on a better return on your cash because your money is tied up.

Instead savers should look for the best possible easy access deal or a short-term fixed deal. At the moment these include Nationwide’s My Save Online Plus Issue 4 which pays 3.12% and offers easy access and Allied Irish Bank’s one-year bond at 3.40%.

More: Which savings account should you get? | Fight back against inflation