Get your finances in order

The Governor of the Bank of England has warned that more Bank rate rises are likely to be coming – so cut back on your spending now before your interest payments become too much for you to manage. Governor Mervyn King still has major concerns over a number of indicators that suggest that the economy is still overheating and that inflation is not yet under control.

Most economists and industry watchers now firmly believe that interest rates will hit 6% before the end of the year. That would mean an inevitable rise of the Standard Variable Rate for mortgages to 8%, which would be its highest level since December 1998. Although those with fixed rates are protected from mortgage rate changes in the short term, those with discounted mortgages or tracker mortgages will see their mortgage rates change – upwards. Many of those with fixed rates will have their fixed period come to an end in the next few months – and they will be in for a nasty surprise when they come to renegotiate their mortgage as fixed rates are much higher now than when they fixed two or three years ago. Some could see changes of £100 month on a £100,000 loan.

Credit card users have also suffered. Many have sent their bank’s interest rates go up as the banks try to recover money they have lost from the imposition of lower penalty charges.

If base rates do continue to rise, the country will face a credit squeeze worse than anything experienced for about fifteen years.

The Governor of the Bank is right: it is a good time to get your finances in order.

A fixed mortgage rate may already be too high to take best advantage of. Those available now already have an expectancy of two more quarter percent rises built in. A tracker might be a better option, in the expectation of rates going no higher than 6%, and hopefully coming down in the future. Be careful of mortgage arrangement fees. Banks are financing their headline rates by lumping bigger fees on customers.

Credit is easily available in modern times. Banks offer large amounts of unsecured debt on credit cards, luring customers with zero percent balance transfers and even zero percent purchases for introductory periods. However, when that period is over, a credit card becomes a very expensive way to borrow money, as interest rates are well over 10% as a standard APR. Those same banks that were keen to lend you money in the first place won’t seem so accommodating if you reach a point where you can’t afford the repayments.

Many people who have mortgages these days can still remember mortgage rates of over 15% in the eighties and marvel at how cheap today’s rates are. But many more people and families will have structured their lifestyle and finances around recent low rates in the hope and expectation that they will remain low for ever. There is no guarantee. Back before the nasty rates of the eighties, in the fifties and sixties, borrowers also had a good time of it. But increases in labour costs and material costs took inflation up, and interest rates followed.

So the nineties and early part of the twentieth century may become the fifties and sixties, when looking back from the tens and twenties of the new century. That is why Mr King is determined to keep the lid on inflation and has warned people to get their finances in order.

And if you think that only borrowers will suffer from the effects of inflation and rising money costs, think again. The consequences will be more widely felt by different members of the country.

If you’re a pensioner on a fixed income, then if inflation continues to rise, your spending power will be reduced. This is a particular issue for anyone with a level annuity, that will pay the same amount of income throughout the whole of retirement. These looked more attractive than an inflation-linked annuity, which appear to pay a smaller income, but move up with inflation – to a maximum of 5% a year. If inflation continues to rise then in ten years time every £1000 will be worth only £644 for those with fixed annuities.

This gives those coming up to retirement a difficult decision to make: take out a fixed level annuity whose value will diminish with inflation; or take out an inflation-linked annuity and see income fall straight away with some protection in the future. For those with some savings backing them up, they might take income from their pension fund and invest it in the stock market, but if that suffers a fall they are at risk of losing some of their fund. Once again this demonstrates how the Government should give greater attention to pension income in retirement.