Base Rate Cut To 1%

For the fifth month in a row, the Bank of England has chopped its base rate, this time from 1.5% to 1%. However, the credit crunch still means high rates for most borrowers.

For the fifth month in a row, the Monetary Policy Committee (MPC) of the Bank of England has lowered the Bank's base rate. Today, the base rate was cut from 1.5% to 1%, a reduction of a third (33%). Here are the last five cuts:

As you can see, the base rate has plummeted from 5% in early October to just 1% today -- the lowest rate in the Bank's history, and a fall of four-fifths (80%). Although I haven't checked all the data from the Bank's 315-year history, I suspect that the base rate has never before been cut by 80% in five months, making this the steepest decline since the Bank was founded in 1694.

A benefit for borrowers

The UK has 25 million households, 11.7 million of which have a mortgage. So, almost half (47%) of all households have a secured loan to repay. Hence, they will welcome the news that the base rate is the lowest it has ever been. Sadly, not all homeowners will benefit. In fact, under half will be better off as a result of the latest 0.50% cut.

This is because half of all homeowners have fixed-rate mortgages, which means that their repayments are unaffected by changes to the base rate. However, as fixed-rate deals expire, these homeowners can shop around for a better deal, either staying with their existing lender or remortgaging elsewhere.

Then again, according to Fool partner Moneyfacts, getting a low-rate mortgage is a real challenge if you don't have a hefty deposit. Indeed, almost two-thirds (64%) of home loans now require a deposit of at least a quarter (25%) of the purchase price. Only two lenders will lend to homebuyers with no deposit (Northern Bank in Northern Ireland and Tipton & Coseley BS in the Midlands), and at rates above 7% a year.

The people who will benefit most from this news are homeowners whose mortgages track the base rate. Around one in ten mortgages (10%) is a tracker loan which moves up and down in line with the base rate. These lucky people will see their monthly repayments drop by a third for interest-only loans, but a bit less for repayment mortgages.

Alas, some lenders impose a `collar' on tracker mortgages, which means that rates on some trackers won't fall, despite the base-rate cut. For instance, with a collar of, say, 3% a year, your tracker rate cannot fall below 3%, even if the base rate is cut to zero. So, not all tracker borrowers will enjoy lower repayments after this latest 0.5% cut to the base rate.

The remaining 40% of borrowers have variable-rate mortgages, most of which are linked to their lender's standard variable rate (SVR). Some will benefit more than others, because SVRs vary enormously among lenders, with the highest being more than two full percentage points above the lowest. What's more, some lenders have repeatedly failed to pass on base-rate cuts in full (notably, Barclays/Woolwich) and others drag their feet for months before lowering their SVRs.

Non-mortgage borrowing is still expensive

Another point worth mentioning is that the plunging base rate is having little effect on the cost of unsecured (non-mortgage credit). Indeed, credit and store cards are still enormously expensive, especially when compared to the base rate. A typical credit card charges 17.7% APR on purchases and, for store cards, yearly interest rates approach 30% APR. Today, some store cards charge borrowers thirty times the base rate. That's a disgrace!

However, there is good news for some Barclaycard customers, who will benefit from lower interest rates. Earlier this week, Barclaycard announced that it was cutting interest rates for three million of its lowest-risk cardholders. These lucky few will see their annual interest rate cut by between 2½ and 5 percentage points. However, the remaining nine million Barclaycard customers -- three-quarters of the total -- will see no change to their borrowing costs.

Likewise, approved overdrafts on current accounts cost between 12% and 20% a year in interest, with unapproved overdrafts costing twice as much, as well as charging extortionate fines for exceeding your credit limit. Even worse, interest rates are close to zero for credit balances in most high-street current accounts. Is it fair to pay no interest on positive balances, while charging twenty times the base rate on negative balances? I think not!

More suffering for savers

With the base rate heading toward zero, savers are being roasted by rate cuts. Indeed, many savers have seen their pre-tax interest rates collapse from, say, 5% a year down to 1% or thereabouts. Thus, those people who rely on savings interest to supplement their income, particularly pensioners, are facing an 80% cut in this income. In many cases, they will be forced to dip into their savings in order to survive, making them permanently poorer.

Finally, by cutting rates to such a low level, the Bank is actively discouraging saving at a time when the savings ratio is at historic lows. So, while big borrowers benefit, small savers suffer. Again, I would ask if it is right to punish the sensible while rewarding the reckless? And can we really dig ourselves out of our debt hole by borrowing ever-greater sums? With the Bank of England rapidly running out of ammunition, only time will tell as to how well the UK weathers this storm...

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