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 moneysupermarket.com.
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.
The circumstances in which a property is worth less than the outstanding mortgage debt secured on it. Although it traps householders in their properties, the Council of Mortgage Lenders (CML) says there is no causal link between negative equity and mortgage repayment problems. At the depth of the last housing market recession in 1993, the CML estimated 1.5 million UK households had negative equity but most homeowners sat tight, continued to pay their mortgages and eventually recovered their equity position.
Loan to value
The LTV shows how much of a property is being financed and is also a way to tell how much equity you have in a property. The higher the LTV ratio the greater the risk for the lender, so borrowers with small deposits or not much equity in the property will be charged higher interest rates than borrowers with large deposits. The LTV ratio is calculated by dividing the loan value by the property value and then multiplying by 100. For example, a £140,000 loan on a £200,000 property is a LTV of 70%.
Changing mortgages without moving home. Property owners chiefly remortgage to get a better deal but some do so to release equity in their homes or to finance home improvements, the costs of which are added to the new mortgage. Even though you’re not moving house, you still need to engage solicitors, conveyancing and the new lender will require the property to be surveyed and valued.
With a tracker mortgage, the interest you pay is an agreed percentage above the Bank of England’s base rate. As the base rate rises and falls, your tracker will track these changes, and so rise and fall accordingly. If your tracker mortgage is Bank of England base rate +1% and the base rate is 5.75%, you will be paying 6.75%. Tracker rates are lower than lender’s standard variable rate (SVR) and as they are simple products for lenders to design, they usually come with lower fees than other mortgage schemes.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
Every mortgage lender has a standard variable rate of interest, or SVR, on which it bases all its mortgage deals, including fixed and discounted rate and tracker mortgages. When special deals come to an end, the terms of the deal usually state that the borrower has to pay the lender’s SVR for a period of time or pay redemption penalties. The lender’s SVR is, in turn, based on the Bank of England’s base lending rate decided by the Bank’s Monetary Policy Committee (MPC). Every time the MPC raises its rate, mortgage lenders generally increase their SVR by the same amount but when the MPC lowers its rate, lenders are often slow to pass this on or don’t pass on the full cut to borrowers.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
Moving money from one account to another, whether switching bank accounts or more likely transferring the outstanding balance on your credit card to another card that charges a lower – or 0% – rate of interest. Some card providers may charge a transfer fee that can be a percentage of the balance transferred.
This type of insurance covers the structure and fabric of your property – the bricks and mortar, not the contents (for which you need contents or home insurance). If you have a mortgage, the lender will insist you have a suitable buildings insurance policy in place. Many lenders offer their own building insurance policies, but you don’t have to buy it from your own lender but you have the option of shopping around. The insurance covers you for the rebuilding costs, not the market value of the property.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.