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Interest rate changes and affordability at Zopa

After more than a decade the Bank of England has raised interest rates. They’ve only ticked up by 0.25%, but it’s a shift in direction and the first time we’ve seen this for a while.

A higher interest rate environment isn’t something new for Zopa. When we made our first loan in 2005, interest rates were at 4.75%. And in our first five years, the Bank of England base rate varied from 5.75% to 0.5%. So, while it seems like a big change its actually quite modest – and we’re very used to lending in higher interest rate times.

So what will the rate rise mean for people’s finances?

Firstly, if you have any variable debt, like a tracker mortgage, then that will become slightly more expensive.  According to a report on the BBC, the expected change to the average tracker mortgage is around £12 per month. (Though in an ideal world, interest rates should also curb inflation, so while mortgages may get more expensive, if it’s effective it should mean that prices elsewhere aren’t rising as fast.)

Secondly, a rate rise often translates into higher prices for borrowers taking new loans of all types.

A third impact is that it also usually translates into higher savings rates.  But, historically the rate rises don’t always get fully passed on, so savers get a bit more, but not all of it!

So what does it mean for your Zopa investments?

Things may get a little more expensive for some borrowers, but we don’t expect this to have a material impact on the performance of Zopa loans (and so we don’t expect losses to change).

This is because we focus on low risk borrowers, and because we have strict criteria on whether our borrowers can afford their loans.  Before we approve anyone, we assess their affordability by looking at their income and outgoings and try to make sure they can make the monthly payments.

When you’re thinking about your returns, it’s important to note that the link between the base rate and the return from your Zopa investments isn’t a direct one.

The rate of return you receive from your Zopa investments is a blend of the interest rates of the different loans you invest in, minus bad debt and fees. And our loans’ interest rates are set within the context of the wider market – we have to price them competitively to make sure that we attract the most creditworthy borrowers to Zopa.

There is a chance that lenders, who are already expecting further increases in defaults (as reported in the latest Bank of England Credit Conditions Survey), may increase their prices, but we’ll have to wait and see. We monitor pricing in the market in real time every day and are prepared for changes in either direction. If we do see a shift in the market, we’re ready to act and we’ll let you know.

I’d really like to know what you think about yesterday’s developments.  If you have any thoughts you would like us to discuss, please email us on performance@zopa.com.