Page last updated at 11:29 GMT, Thursday, 4 June 2009 12:29 UK

What now for borrowers and savers?

By Kevin Peachey
Personal finance reporter, BBC News

Piggy bank
The Bank of England's move was widely expected

For the third month in a row, the Bank of England has decided to keep interest rates unchanged at 0.5%.

The UK is still in recession, activity in the housing market remains low and savers are receiving small returns on their funds.

Mortgage rates are unlikely to fall any further. According to the Halifax house price survey, repayments have become much more affordable for the average homeowner.

Yet savings rates, on average, have dipped again and remain at record low levels.

Savings

For six months in a row from October, the Bank of England's Monetary Policy Committee cut the Bank rate so it dropped from 5% down to 0.5%.

In the current low interest rate environment there is evidence that households are looking to repay debt rather than save
Brian Morris, Building Societies Association

As a result, the returns for savers dipped sharply, causing concern among groups representing older people. They said that many older people supplemented their pensions with interest gleaned from their life savings.

Some 27.5% of all variable rate savings accounts currently pay 0.10% or less, according to financial information service Moneyfacts.

Figures from the Bank of England show that rates pretty much hit rock bottom by the end of January and have stayed there since.

The average interest rate from instant access accounts in the UK, including current accounts, stood at 2.77% at the end of January 2008.

But a year later this figure had dropped to 0.21%. A month later it was down at 0.16% and at the end of April - the latest figures available - it was at 0.16% once again.

Rates on tax-free Individual Savings Accounts (ISAs) dropped sharply between the end of October and the end of April, with rates cut by a number of providers in the last week.

"It is starting to look as if some providers may have reached their targets for Isa deposits already and are content to offer a poorer deal to those who have been slow off the mark," said Andrew Hagger, of financial website Moneynet.co.uk.

Monthly average interest rates on fixed-rate bonds have shown slight signs of recovery, according to the Bank of England.

At the end of April, the figure stood at 2.7%, up from 2.49% at the end of January. But this was still much lower than the figure of 4.95% seen a year earlier.

Banks and building societies say they have attempted to retain and attract savers by keeping interest rates up, and as a result have decided not to push mortgage rates down further.

Mortgage rates

Mortgage holders have benefitted from falling interest rates - most notably those with tracker deals.

The latest Halifax house price survey found that the proportion of disposable income spent on mortgage repayments by a new borrowers dropped from a peak of 48% in the third quarter of 2007 to 31% in the first three months of this year.

Some experts suggest that those on tracker deals, or who come off fixed-rate deals onto much cheaper variable rate deals, could take advantage of cheaper repayments by paying off other debts - such as credit cards or store cards - or reducing the lump sum of their mortgage.

Alternatively, with savings fetching small returns, these could be withdrawn to pay off debts.

Brian Morris, head of savings policy at the Building Societies Association, said: "In the current low interest rate environment there is evidence that households are looking to repay debt rather than save, and it is possible that there will be a net withdrawal - before interest credited - from the total UK savings market in 2009."

Many home loan providers have not passed on all of the Bank rate cuts through to their standard variable rates (SVRs).

In April, the UK's biggest building society, the Nationwide, announced it would no longer promise new borrowers that it would peg its variable rate mortgages to the Bank rate.

Mortgage rationing also remains a factor, as lenders remain keen to offer home loans to "safe" borrowers.

Of the 1,623 mortgage deals currently on offer, two-thirds still require a deposit of at least 25%, with a quarter of all deals needing a down-payment from the borrower of at least 40%, according to Moneyfacts.

Long-term deals

Figures show that the annual rate of decline in house prices has eased in recent weeks, with data and anecdotal evidence from estate agents reporting a lift in interest from buyers.

Borrowers tend to be looking towards longer-term fixed rate mortgage deals at present. While getting a two-year fixed-rate mortgage might lead to cheaper repayments in the short-term than a five-year deal, when it comes to renewing, analysts suggest interest rates are likely to have risen again.

"It remains very uncertain how long Bank rate will stay at 0.5% but what one can be certain of is which way it will move when it does change," said Ray Boulger, of UK mortgage broker John Charcol.

"A fixed rate for at least five years will be needed to protect borrowers from the next upward interest rate cycle."

Andrew Montlake, director of independent mortgage broker Coreco, said: "The smart money is now on longer-term fixed rates, with five-year fixes remaining the most popular.

"Fixing at below 4.5% for five years in any market is competitive, but especially so when competition between lenders is weak and the only direction for interest rates is up."



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