Make the most of falling costs

Despite the recession, rising unemployment and general economic doom and gloom, many of us should be feeling a little richer, according to new research. The historically low Bank of England base rate, combined with cheaper bills, mean households have seen their disposable income increase by an average of 25% over the past 12 months.

Assuming you are fortunate enough to have kept your job during the recession, then you should have an average of £1,075.22 left over each month after tax contributions and monthly bills, according to Ernst & Young research. This is up £200 from 2008.

Lower mortgage repayments are one of the biggest drivers in the increase in disposable income, with the average family paying 20% less this year to meet their mortgage debt than in 2008.

However, this is based on the assumption that these families are currently on their lenders’ standard variable rates (SVRs), which have fallen in response to the low base rate. If you are on a tracker mortgage, meanwhile, your repayments are likely to be even cheaper - but those on fixed-rate deals will have seen no change to their monthly mortgage costs.

Cheaper petrol, energy bills and food have also helped boost disposable income. Ernst & Young says fixed monthly household costs have fallen by almost 8% over the last year.

“Even though we’re still in recession, many UK householders who have not been hit by unemployment have experienced a dramatic upturn in their monthly budgets over the last year,” explains Jason Gordon, retail director at Ernst & Young.

However, apart from the fact this research relies on several factors that will not be true for all families, the suggestion that monthly incomes are up does not tell the full story.

"Although a typical consumer with a mortgage may now have more money to spend on a monthly basis, the sharp house price declines of the last 12 months have significantly eroded their overall wealth,” Gordon adds. “Falling house prices, the bleak economic climate and fears of job losses have had a devastating impact on consumer confidence.”

At the same time, some costs are rising at a rate above inflation. Many households will have seen their council tax bills, for example, rise by an average of 3%, while the cost of buildings insurance and public transport have also increased over the past year.
Gordon says that people who have seen an increase in their disposable income are using this cash to boost their savings, pay off credit cards and loans and lower their mortgages. “These gains are certainly not being spent freely on the high street,” he adds.

How should you spend it?

If you have seen your deposable income increase as a result of the low base rate and cheaper household bills then you may well be tempted to treat yourself and your family. But, as Gordon points out, the grim economic climate means this might not necessarily be the best course of action.

Generally speaking, the three ‘best’ ways to use any additional money are:

1. Pay off your debt

Credit cards and personal loans are often a necessary way to fund a big purchase and then spread the cost over time. However, it can be easy to build up debt using plastic and loans, and the high interest rates that come with both these types of credit mean you could end up owing more and more each month.

However, by increasing your repayments you can cut the overall amount you owe and reduce the amount of time it takes to clear this. For example, a borrower with a £1,000 balance on a credit card at 16.9% APR who pays the minimum repayment of 2% for 12 months, will rack up £151.74 in interest – and only bring the total debt down to £920.60 – according to research by

But the same customer could slash their overall balance by nearly £400 and pay nearly £30 less in interest by increasing their repayments to 5% (£50) per month. Paying 10% per month (£100) would enable the borrower to clear their debt in 12 months and only pay £79.16 in interest.

If you have any outstanding credit card debt then it’s worth moving this onto a 0% balance transfer deal, such as Virgin Money’s MasterCard. This card gives you 16 months to clear your balance without attracting any interest. Just bear in mind that a balance transfer fee of 2.98% (minimum £3) applies and that if you fail to clear your balance within 16 months you will start to attract interest of 16.6% APR.

Before you even think about applying for a 0% credit card, however, it is vital you check your credit record. Interest-free credit cards are normally only issued to people who have a squeaky clean track-record of meeting their debt commitments – and if you don’t fit a credit card provider’s criteria and it rejects your application then your credit rating could be damaged further. Find out more here.

In order to tackle your debts, it’s worth writing up a monthly budget - you can do this using Moneywise’s interactive budget planner. Once you’ve taken all your essential and fixed costs into account, you’ll get an idea of how much money you have left over that could be used to clear your debt.

Next, write a list of all your debts, making a note of any interest-free periods, the interest rates you are paying and whether there are any restrictions on early repayments. For example, some personal loans might charge you a fee if you clear the debt within a certain period, and a mortgage provider almost certainly will (see below).

2. Build up a savings pot

If possible, you should aim to have a savings pot equivalent to at least three months' income just in case the worst happens and you lose your job or just need the cash for an emergency.

An instant access ISA is probably the best home for this ‘savings buffer’ as providers will allow you access to your money and it will grow tax-free. You can save up to £7,200 in an ISA each tax year, of which £3,600 can be held in a cash account. From 6 October, the ISA allowance increases to £10,200 for the over 50s, of which £5,100 can be held in cash. This new ISA allowance will apply to younger savers from April next year.


Alternatively, an instant access savings account will do the job, if you’d rather use your ISA allowance to lock away a lump sum or invest in stocks and shares.

Just watch out for any withdrawal restrictions; there are deals on the market that restrict the number of withdrawals you are allowed to make, or hit you with a penalty in any month you access your cash.

Also, be aware of bonus rates – while these will boost your returns in the short term, you need to make sure you make a note of when the introductory rate ends or see your returns fall.

Once you have built up an emergency pot, you can consider different methods of saving. A fixed-rate deal is ideal if you want to lock away a set amount of money for a pre-agreed period of time. If you haven’t used your ISA allowance, then you can opt for a fixed-rate tax-free account to lock away your cash in. However, withdrawals will not be permitted and you may not be able to make further deposits either.

A regular savings deal is also a good way to build up a savings pot. These require you to set up a monthly standing order from your current account, so you put away a set amount each month. You can either opt for a fixed or variable-rate, and some providers will also allow you to make withdrawals in an emergency.

Just remember, though, if you miss a monthly payment you may be hit with a penalty charge or see your interest rate fall for that month only. You can also get regular ISA savings accounts, so this is another option if you haven’t used your allowance.

3. Overpay on your mortgage

Don’t look a gift horse in the mouth. If you’ve seen your mortgage costs fall – perhaps because you’re on your lender’s SVR, have a tracker loan or have benefited from cheaper rates on new fixed-rate deals – then use this money wisely.

Obviously you might prioritise paying off other debt or building up your savings – but if this isn’t the case then you should seriously consider trying to reduce the size of your mortgage by making overpayments.

Other than the fact this will reduce your overall mortgage term and the total amount of interest you pay on the loan, overpayments makes sense in a weak housing market.

Falling house prices mean increasing numbers of people are at risk of negative equity – where their mortgage debt is more than the value of their property. While this is just a paper loss (unless you have to sell your home), being in negative equity will prevent you from moving onto a new tracker or fixed-rate mortgage once your current deal’s introductory period ends.

This mean you could end up being stuck on your lender’s SVR – and while this might be pretty cheap at the moment, once the Bank of England starts to increase the base rate (as it surely will, potentially later this year), your repayments will increase, possibly quite sharply.

Even if you aren’t at risk of negative equity or looking to move, then you should still be aware of the danger posed by house price falls. Just as first-time buyers need to put down a deposit of at least 40% to benefit from the most competitive mortgage rates, people remortgaging onto new deals are required to have a decent equity stake in their homes.

Lenders take the loan to value (LTV) – that is, the amount you need to borrow versus the value of your home – into account when they price mortgages. So, if you have a 40% equity stake in your property (meaning you require a 60% LTV mortgage) then you are likely to be offered the best rates by lenders. If your LTV is 75%, you will probably be offered a slightly less competitive deal and so on.

House price falls could see you move from one LTV band into another – meaning you risk having to pay more on your next mortgage. By making overpayments you could potentially offset house price falls, and save yourself money down the line.

Bear in mind, though, that unless you are on an SVR you might not be allowed to make overpayments. Check with your lender to find out how much you are allowed to overpay before you are hit with a penalty.