What are interest rates? A quick guide

11 May 2023

What are interest rates? A quick guide

An empty wallet superimposed on an upward arrow, symbolising rising rates

Interest rates are big news when they change - but why? If you're not familiar with what they are and how they affect you, here's our quick guide to what it all means.

Interest is the extra cash you get charged for a loan

If a friend loans you £10 at a 10% interest rate, you'll pay them back £11. That's the £10 you borrowed plus an extra £1 (10% of £10) as interest. Banks have more complicated ways of calculating this, but that's the general idea.

Rates are just how much interest you pay

If you hear about rates going up, that means you'll pay more interest on borrowed money. You might also hear people talk about getting better rates on some bank loans, or really high rates on things like credit cards and payday loans.

They're a big deal for people with mortgages

Mortgages are special - they take decades to pay back. So to make sure banks don't lose money in the long run, the interest rate gets renegotiated at least every few years. Given the loan is so big, small changes of a few percent could mean spending hundreds of pounds more each month.

There are many different types of mortgages

A fixed rate mortgage is when the homeowner commits to repaying a certain fixed amount each month for a set period of time. The interest rate is frozen until the deal ends, when the repayment is renegotiated. A variable mortgage moves up or down with interest rates, so repayments rise and fall.

Will your mortgage go up?

If interest rates jump upwards, first-time buyers with a mortgage could see their monthly repayment increase, for instance, from 3% to 5% or more. This might be too much for many to afford. Regulated mortgage advisers can search the market and recommend the best deal, but you might have to pay for their services.

How high could interest rates go?

The Bank of England may increase interest rates if it thinks prices are going up too quickly - called inflation. Higher interest rates can discourage people from taking out loans or spending on their credit cards. This means people have less money to spend, so price rises slow down. But, it can hurt people already struggling to afford things, and there is no telling how high rates could eventually climb.

But high interest rates can be good, too

If you have money in savings, higher interest rates should make the interest you earn on your funds go up - since you're basically loaning the bank your money while they hold on to it. But banks are often pretty slow to pass on the extra cash to customers - and sometimes don't bump up their payouts at all.

What are interest rates? A quick guide