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 amount you get charged when you borrow money

If someone lends 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) in interest. Repayments usually happen regularly over a set period of time, such as monthly payments for several years. Banks have more complicated ways of calculating interest rates and repayments, but that's the general idea.

The Bank of England sets a base interest rate

The Bank of England's base rate is what it charges other lenders to borrow money. When it changes, it affects the loans and savings deals that High Street banks and building societies and other lenders charge their customers. The Bank of England reviews the base rate around every six weeks.

What happens when interest rates change?

When interest rates rise, it becomes more expensive to borrow money and, when they drop, it becomes cheaper. Interest rates rose after the Covid pandemic - climbing to more than 5% before falling back. Rates are expected to drop gradually in 2025.

How does the Bank of England base rate affect mortgages?

Mortgages - the loans people take out to buy a house which typically take decades to repay - are more expensive than they have been for most of the past decade because of high interest rates. This is because if the Bank of England base rate goes up, the monthly repayments on mortgages tend to go up too, but this depends on the type of mortgage you have. There are two main types.

Fixed-rate mortgages

People with fixed-rate mortgages are not affected by changes to interest rates straight away because the amount they pay back each month is fixed for a certain period of time, such as two or five years. At the end of that period, the interest rate on their next mortgage could be different, and if the Bank of England base rate has gone up, they could end up paying more each month.

Tracker mortgages

Tracker mortgages effectively follow the Bank of England base rate. If the base rate goes up or falls, the monthly payments change too.

Why does the Bank of England change interest rates?

The Bank of England puts up interest rates if the costs of goods and services are increasing too quickly (known as inflation). The idea is to discourage people from borrowing money. When rates rise, people tend to spend less and save more. That slows the demand for goods and services, which can limit price rises.

What do higher interest rates mean for savers?

If you have savings, higher interest rates should mean the interest you earn goes up - since you're basically lending the bank your money.

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