Interest rates, as set by the Bank of England, have a significant influence over other areas of the economy. While not the sole factor, interest rates influence the price of goods and services, property, and, most notably, credit. The fluctuation of interest rates can greatly impact loans in a number of ways.
In this article, we will discuss how interest rates impact loans, what loans they can affect, and how you can obtain the most affordable loans regardless of interest rate increases. Let’s get started.
How do interest rates impact new loans?
Changes in national interest rates can impact borrowers looking to take out a new loan in two key ways. First, interest rate changes can greatly affect how much a borrower should expect to pay each month. Should the interest rates decrease, borrowers can expect to make smaller monthly repayments, which could be an influential factor in decision making. This is especially true for fixed-rate loans, as you may be able to lock in at a lower rate, even if the rates increase. However, the reverse can be true for variable-rate loans; if you take out a variable-rate loan when interest rates are low, you may end up paying overall should they be increased.
Price is not the only area impacted by interest rate changes. Depending on the change in question, loans may see an increase or decrease in availability, influencing how difficult obtaining a new loan may be. Moreover, the changes may even impact how you use the loan. For example, if you intend to take out a mortgage during a time of high interest rates, you might find it more of a challenge to purchase a suitable home. Most people prefer to sell their home during times of low interest rates, as this means they can potentially switch out a higher-rate mortgage for a lower-rate one. This saves the seller money overall, increases willingness to sell, and helps you find your dream home. The reverse is true for high interest rates, and is certainly worth considering.
How do interest rates impact existing debts?
Any change in national interest rates impacts borrowers with existing loans, whether it be a credit card, personal loan, or even mortgage. In the context of interest rate changes, there are two main categories of loans to consider – fixed-rate and variable-rate loans. Interest rate changes do impact both loan types, but the effects are not identical.
Variable-rate loans are impacted the most by national interest rate changes, with the effects of any such change being felt quickly. True to the name, variable-rate loans are prone to fluctuations, and it is not uncommon for small changes to occur even during periods of stability. However, the effects of these fluctuations are a double-edged sword. Should interest rates decline, a variable-rate loan will reflect the change, resulting in smaller interest payments. On the other hand, if there is an increase in interest rates, then borrowers with variable-rate loans can expect to pay more in interest. While any increase in monthly repayments isn’t ideal, this can be disastrous for mortgages, especially in cases of prolonged or successive interest rate hikes.
Interest rate changes
Fixed-rate loans, most commonly used in mortgage products, are not as impacted by interest rate changes. Fixed-rate loans are exactly that, loans with a fixed interest rate for a specified duration. While this duration varies between lenders, a fixed-rate loan term typically lasts for a number of years before the interest rates are revised. If you can fully repay your fixed-rate loan during this period, national interest rate changes will leave you all but unaffected. However, if you cannot, then your fixed-rate loan will be adjusted to reflect the changes. During periods of interest rate instability, this can result in you being locked into paying much less than the going rate. Conversely, you could end up paying significantly more in interest should the interest rates drop after your fixed-rate loan has been revised.
When should I aim to take out a loan?
When planning to take out a loan, there are a handful of factors to consider. Arguably, the most important factor to consider is expense. Taking out a mortgage at high rates to purchase your dream home is all for naught if you can’t endure the interest payments. As such, aiming for times when interest rates are low is generally advisable. Not only will this reduce the overall cost of your loan, but you’ll also find better applications for the money. Homeowners are more likely to sell, contractors are less expensive as they don’t have to offset the cost of higher interest rates, and so on. Moreover, taking out a fixed-rate loan can help insulate you from the effects of an increase in national interest rates, ensuring you retain affordable monthly repayments.
How to minimise the cost of a loan
Borrowers can take a variety of measures to reduce the cost of their loans, even during periods of high interest rates. The following are some such methods:
- Build credit score – A high credit score is the gateway to favourable loans. Building your credit score can be done through making regular monthly repayments, which will be helpful when the time comes for larger loans, such as a mortgage.
- Utilise secured loans – Using secured loans, or loans that require physical assets to be used as collateral, often cuts down on the overall cost. In exchange for assuming higher risk, as lenders can seize collateral assets should you default, secured loans typically have lower interest rates, and some come with fewer additional fees.
- Allocate loan funds – Creating a thorough plan before taking out a loan can save you money. If you work out precisely how much a purchase, project, or otherwise costs, you can borrow the exact sum you need. This will ensure you don’t unnecessarily pay more interest, lessening the overall cost of your loan.
- Be discerning when choosing a lender – Different lenders offer different rates and include different fees. Although it takes time, shopping around can result in cheaper loans, lessening the strain on your finances.
Wrapping up
Interest rate changes can impact loans significantly. The main area they influence is cost, either creating loans that are cheaper, or more costly, though these changes can have additional consequences. To ensure you obtain the most affordable loans possible, it is a good idea to consider how national interest rates will affect your preferred loan. To do so, enlisting the aid of a financial professional can be greatly beneficial.