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Higher interest rates are going to be around for a while, which carries implications for savers and borrowers. Here's how you can balance the effects on your finances.

For the past two years, the Bank of England has been raising interest rates to try to bring down inflation.

From historic lows of 0.1% in December 2021, the Bank's Monetary Policy Committee has gradually raised rates 14 times, to 5.25% in August 2023. 

It's done the trick – to some extent. The Consumer Prices Index rate (the change in price over a period of time of a weighted average basket of consumer goods and services purchased by households) has come down from its peak. A slowing in price rises across housing, food, and restaurants has helped to bring the overall rate of inflation down to 4.7% as of October 2023.

However, the Bank is committed to targeting an inflation rate of 2%, so there is still work to do. Indeed, the International Monetary Fund and the Bank of England have said that the UK will need to keep rates high for some time.

What does this mean for savers and investors? We look at ways to ease your outgoings while interest rates on loans are higher – and make the most of higher rates on savings. For those for whom it's appropriate, we also look at the options for investing. 

How to manage higher mortgage costs

Higher mortgage payments are one of the places where many feel the pinch the most. However, interest rates on credit cards, loans and even on money you owe to the taxman have also risen as the Bank of England has hiked its base rates.

On the assumption that rates are unlikely to return to previous lows anytime soon, tackling this debt is more important than ever.

This may mean overpaying on your mortgage to get a cheaper rate when you re-mortgage. It could also mean diverting money, such as bonuses (that might otherwise go into savings or a pension) into paying off debt.

Some people are extending the terms on their mortgages so that they pay them off over more years but at a lower monthly figure. This means paying more interest over time but may be unavoidable.

How to manage credit card debt

If you have credit card debt, one solution may be to consider a zero percent balance transfer credit card. This option may allow you to transfer your debt on to a new card, often for a small fee, and then give you a period to pay it off without accruing interest.

Some balance transfer cards last for more than two years. However, you will need to make a plan to clear it during the period.

If you are struggling with debt from various sources that you cannot pay back, your first step should be to seek advice.

In a high-interest rate environment, some debts will be more expensive than others and could snowball quickly, while other types of debt could have a detrimental effect on your credit rating or result in you losing essential services.

How to get advice if you are in debt

Taking advice will ensure you prioritise the debts that must be paid off first, while trained professionals can help you to make a plan with creditors. Consider approaching organisations such as Citizens Advice and StepChange.

These debt advisers may also be able to help you to get on to the Government’s Breathing Space scheme, which gives you 60 days during which creditors cannot add interest and charges to your debt.

The scheme covers loans, overdrafts and arrears on household bills, as well as credit card and store card debt. However, you must speak to an adviser to get onto this Government-backed scheme.

These advisers could also help you to consolidate your debt if this is appropriate for you.

One option may be a debt consolidation loan which combines all your existing debt into one payment. This could decrease the amount of your salary going towards high credit card interest or pay off overdue accounts like your energy bill, which could improve your credit rating.

However, there are arrangement fees to consider, and you may be able to secure a better plan by speaking to your creditors directly.

A mortgage adviser may be able to find you a deal that could consolidate high-interest credit card or personal loan debt when you are in the market to remortgage.

Just remember that a lower rate paid over a longer period will usually end up costing you more. Adding more debt to your mortgage could also create a problem if your home falls into negative equity because house prices can drop below what you paid for the property.

Alternatives such as these can give households more day-to-day spending money while the cost of living and interest rates remain high. However, there are always risks to consider when consolidating debt, such as secured loans which could put your home at risk, so you may wish to seek expert advice. 

How to maximise your savings

If you are in debt, it may be better to tackle this first before considering savings.

For those that can afford to save, it’s clear that not all banks are passing on rate rises to existing savings customers. You may want to shop around and consider fixed-rate accounts if you are willing to tie money up for a period.

As rates rise, you are more likely to end up paying more tax on your cash savings unless you take action.

For example, if you pay a higher rate of tax, you will have a £500 personal savings allowance, which means you can earn this much in interest before paying tax. Basic rate taxpayers can earn £1,000. 

Making use of your annual £20,000 a year ISA allowance can help ensure you do not end up paying tax on your savings. You can pay into both a stocks and shares and cash ISA in any tax year up to your £20,000 annual allowance.  

The Lifetime ISA

If you are saving for a house deposit, those eligible may want to consider a Lifetime ISA (LISA), which is available as a cash product, or as a stocks and shares option for those that can afford to invest. However, please note that investing should come with a longer time horizon, of at least three years, and products may carry a fee. 

Those eligible can invest up to £4,000 per year with a 25% government bonus on contributions up to the annual limit. However, terms and conditions do apply and those accessing their money outside of a property purchase or retirement will pay a 25% withdrawal charge.

To open a LISA you must be 18 or over and under 40 years of age. The Government allows you to put in up to £4,000 each year until you’re 50. However, you will have to make your first payment into your ISA before you turn 40.

The money in your LISA can be used to purchase a first property worth up to £450,000. If you do not use your LISA to purchase a first property, you have two other options. You can withdraw the money without penalty after the age of 60 or if you become terminally ill.

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Investing via a stocks and shares ISA or pension

If you have a longer time horizon to meet your goals, or at least three years, and can afford it, you may want to consider investing.

Studies suggest that over longer periods putting your money into shares tends to produce better outcomes than keeping it in cash and can beat inflation. However, investment products may carry a fee and also come with risks, such as losing your initial investment or any gains you have made.

You can also use a stocks and shares ISA to invest in a tax-efficient manner, with no tax paid on growth or returns.

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Your pension may also be a major investment focus for you, both in the early days of your career and later as you get closer to retirement.

The younger you are, the longer your pension pot(s) will have to grow, and this will be helped by tax breaks from the Government and any contributions to workplace pensions made by your employer.

For those edging closer to retirement, a high-interest rate environment could mean that buying an annuity with your pension once you reach pension age to give you a guaranteed lifetime income is a more attractive option than in recent times. The rates offered by annuity providers are closely linked to interest rates, and so tend to be more generous as base rates rise. 

The emphasis in the current environment is balancing the competing demands on your finances, making the most of high savings rates and ensuring you keep debt under control as much as possible.

If you would like to discuss your financial goals further, you can book a free call with one of our experts. 

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance. Tax treatment depends on your individual circumstances and may change in the future.

A stocks and shares ISA may not be right for everyone and tax rules may change in the future. If you are unsure if an ISA is the right choice for you, please seek financial advice.

A stocks and shares Lifetime ISA may not be right for everyone and tax rules may change in the future. You must be 18–39 years old to open one. If you need to withdraw the money before you’re 60, and it’s not for the purchase of a first home up to £450,000, or a terminal illness, you’ll pay a 25% government penalty. So you may get back less than you put in.

Compared to a pension, the Lifetime ISA is treated differently for tax purposes. You may be better off contributing to a pension. If you choose to opt out of your workplace pension to pay into a Lifetime ISA, you may lose the benefits of the employer-matched contributions. If you are unsure if a Lifetime ISA is the right choice for you, please seek financial advice.