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How The Bank of England Rate Impacts Different Kinds Of Lending
This article was originally the introduction and background to a piece called P2P Lending: How To Deal With Rising Interest Rates. But it got too long, so those tips on lending through rising rates now has its own page. In contrast, the page you're reading now is heavy on the education, but has little in the form of practical tips for P2P lending.
So only read on if you're keen to find out:
The Bank of England base rate is up from 0.1% to 1.75% in under eight months. But people and businesses don't borrow from the central bank. So:
What does “rising interest rates” even mean?
Each bank, P2P lending company or other lending business sets its own rates. So why do we say “interest rates are rising”? It's not as if they set rates collectively.
Most of the time, rising interest rates are driven by the Bank of England, which is a central bank – a bank for banks.
Banks borrow from the Bank of England. As the rate set by the central bank rises, it means the cost of borrowing from it has gone up. Banks need to offset those higher costs by charging their borrowers higher interest rates.
Also, banks place deposits at the Bank of England. (Which holds around £1 trillion in deposits, at present.) When this happens, it's the central bank that's paying interest to the banks. When its rate rises, banks earn more money for keeping more in reserve at the Bank of England, where the money is very safe.
So, banks with deposits at the Bank of England need to charge their own borrowers more, in order to keep making it worthwhile taking the additional risk of lending to individuals and businesses.
How much do interest rates rise, and when?
The scale and speed that interest rates rise for individual and business borrowers after a base-rate rise depends a lot on the type of loan.
Fixed-rate mortgages with a two-year introductory deal went up two percentage points to an average of 3.5%, in the time the base rate rose just 1.15 percentage points. This is because the banks know the base rate will rise a lot further during the two-year deal period.
Overdrafts went up just slightly quicker than base rate and are now a phenomenal 35.3%.
Meanwhile, personal loans are up more slowly, being up just half a percentage point to 8.3%.
Credit-card rates are hardly changed – although, at 21.7%, that's already more interest than a lot of card borrowers can possibly take.
Going further back in history, credit-card rates have generally moved in reasonable lock step with the base rate.
Short-term property bridging loans
Lots of P2P lending companies do bridging lending, so this is of particular interest.
Over the past decade and more, the cost of short-term bridging property loans has been impacted by a large number of factors outside of base rates.
These include more competition driving rates down, a greater number of businesses being able to borrow through property bridges, and improved regulations for borrowers. These factors make it impossible to measure the impact of the base rate cleanly. Not without older, and clearer data, but we don't have that.
As a result of all those factors, based on the sorts of numbers quoted by multiple bridging lenders, borrowers probably today pay on average several percentages points below 20% per year, including fees, while they paid over 20% all-in ten years ago. Even though the base rate is higher now, borrowing costs are still down.
All that said, bridging lenders and brokers appear to be unanimous that borrowing costs usually do rise, at some point, because of the base rate. At least one (non-P2P) bridging lender even launched a new base-rate tracking loan this spring.
Property development lending
Property development lending is also big in peer-to-peer in the UK. Again, though, we have no decent, long-term bank data on rates.
We know that major banks, including NatWest and Barclays, offer development lending linked to base rates.
Of those 36 companies, just six directly link development lending rates to base rates. (None of them the aforementioned P2P lending companies.)
Any impact of base rate rises on development lending is often indirect, because pricing is usually based on the property location, borrower experience, cost of the project, hoped-for sale value of the finished development, and other deal-related factors.
Even so, non-banks used by BrickFlow have put up rates at least a little, due to the overall effect on the entire market. If you think about it, when you have major bank competitors putting up their development loan prices, because banks are tightly impacted by base rates, so too will other, smaller lenders.
An example showing interest rates don't always move with the base rate
Generally speaking, most borrowers end up paying higher costs sooner or later, when the base rate rises.
But, just to emphasise that it's not so clear, here's an example.
The last time the base rate was around today's level, in 2008/9, banks were charging more than 12% on personal loans, versus 8.3% today. That's four percentage points more than today, despite base rates being similar.
Not only that, personal loan rates then continued to rise to nearly 13% over the following months, even as the base rate fell further to 0.5%.
Relating that to P2P lending, you sometimes find a big divergence from the base rate, because many providers are still young and growing fast. Startup P2P lending companies tend to begin with lending rates that are too generous for the risks you take. So their rates fall as the amount of lending grows, and the performance record becomes more and more clear.
For some P2P lending companies, that downward pressure on rates will offset a general rise in rates. We saw this happen over an eight-year period ending in 2016, when the base rate didn't move at all.
Do higher borrower rates mean higher lending rates in P2P?
Exceptions like that aside, P2P borrowing costs will generally be influenced by the base rate. As they are for banks and other lenders, the pace and scale of any increases will largely be shaped by the type of loan.
But what about P2P lending rates? Lenders don't earn everything that borrowers pay. One way or another, the P2P lending company in the middle takes a slice of the earnings made by you when you lend your money.
Read There's No Such Thing As “No Lender Fee for more on that.
Read There's No Such Thing As “No Lender Fee for more on that.
Peer-to-peer lending companies usually take a pre-set proportion of the rewards, so, if borrower rates rise, you should usually expect to see all the benefits passed onto you.
Take Loanpad*, for example, which has increased its top lending rate from 4% to 4.2%, after its borrower rates ticked upwards in recent months. That increase fits with anecdotal evidence from the loan broker BrickFlow on the size of recent rises on development lending that isn't directly linked to the base rate.
What does the data say about trends in P2P lending rates?
You might be wondering why I'm using bank data and not P2P lending data in this article.
Firstly, bank data goes back a lot further.
Secondly, a 4thWay specialist has reviewed the available monthly data submitted to us by many P2P lending companies. While it looks like patterns are forming, it's simply not yet a sufficient amount of data to have high confidence, for any type of lending.
Practical tips on lending during rising rates
If you want practical tips on lending in these times of rapidly rising interest rates, read: P2P Lending: How To Deal With Rising Interest Rates.
Sources: Bank of England; BrickFlow; NatWest; countless bridging and development lenders and brokers.
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