What are interest rates?
‘Buy now, pay later.’
You can borrow money to buy something today and pay for it later. Interest is what you pay for the privilege. It’s a bit like hiring a car – but interest is what you pay to ‘hire’ someone else’s money.
The same principle applies to savings, only here the interest is paid to you – because banks are paying to hire your money.
The interest rate is usually shown as a percentage of the amount you borrow or save. This is paid as interest over the course of a year. So if you put £100 into a savings account that offers a 1% interest rate, then you’d have £101 a year later. If the interest rate was 2%, you’d get £102, and so on.
What is Bank Rate?
‘Bank Rate’ is the single most important interest rate in the UK. It is set by the Bank of England, normally eight times a year. It is sometimes called the ‘Bank of England base rate’ or even just ‘the interest rate’ in the news.
Because it’s the interest rate used by the Bank of England in its dealings with other financial institutions, Bank Rate influences all the other interest rates in the economy. This includes the various lending and savings rates offered by high street banks and building societies.
From Bank Rate to everyday interest rates
When the Bank of England changes Bank Rate, this influences the interest rates you would be offered on loans and savings products.
Take, for example, the cut in Bank Rate in August 2016. This reduced the rates at which high street banks could borrow money. So after the Bank Rate cut, banks became more likely to charge lower interest rates on loans, such as mortgages, and also offer lower interest rates on savings accounts.
In other words, following a cut in Bank Rate, borrowing money should become cheaper, and saving money could become less rewarding.
Why are there so many different interest rates?
The number of different interest rates available when you borrow or save can be mind-boggling.
That is because the interest rates that commercial banks set depend on more than just Bank Rate. For loans, these other factors include the risk that the loan will not be paid back: as this guide explains, the greater the risk, the higher the rate the bank will charge.
Whether you are borrowing or saving, it’s important to shop around. The Money Advice Service has information on what you need to consider.