Are five-year savings deals worth it?
A number of competitive fixed-rate savings account of recently been launched but their long terms mean savers could end up missing out down the line.
Nationwide, for example, has just launched an account paying 4.15% AER - but you will have to lock your money away for five years. Halifax's websaver, meanwhile, also pays 4.1% AER on deposits of £500 but again this is a five-year fixed deal.
The Bank of England base rate is currently at an all-time low of just 0.5%, and opinion is divided as to whether this will stay low for some time or if the central bank might increase it to curb inflation.
With several providers offering better rates for people prepared to fix for some time, the temptation for savers hit by low interest rates might be to grab them while they can. But this is a gamble – even if the base rate does remain low for some time, financial pressures on banks could see many hike savings rates in a bid to tempt in savers and store of their coffers.
David Black, head of banking at Defaqto, says the “noticeable” influx of longer term fixed-rate deals over the past few weeks is mainly down to savings providers looking to secure new customers who won’t disappear after a year or so.
“The general view appears to be that quantitative easing, where the Bank of England creates more money, will push up inflation and, therefore, the base rate as well,” he adds. “The base rate can’t get much lower and will have to rise in the future – the question is, when?”
If you are tempted by the attractive headline rates on longer-term fixed deals, then there are several factors to consider.
First of all, you should never consider locking away your money for a long period of time if you think you might need access to is within that period. Many fixed rate savings account do not allow any early access, and those that do often charge you a penalty for making a withdrawal.
You own view of how base rate might shift in the future is also important. Michael Slade, spokeswoman at data provider Moneyfacts, says savers need to remember that savings – like other forms of investment – is to some extent a gamble.
“No one knows exactly what the future holds for the base rate of the savings market,” she adds. “On one hand, people who want the security of knowing exactly how much interest they will earn on their money might be tempted by three, four or five-year deals. On the other hand, they could lose out down the line if rates on new deals increase.
Black adds: “Sentiment about the base rate can change very quickly – personally, I wouldn’t go for a longer-term fixed deal at the moment. But I could be wrong.”
Opting for a shorter-term fixed deal – such as a 12-month or two-year bond – instead might be more worthwhile, says Matt Hunter, head of personal finance at Confused.com.
“There isn’t a massive difference between the rates of four and five-year account and those fixed for one or two years,” he explains. “Taking a slight reduction in rate might pay off down the line.”
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
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.
Where APR is the rate charged for money borrowed, Annual equivalent rate is how interest is calculated on money saved. The AER takes into account the frequency the product pays interest and how that interest compounds. So, if two savings products pay the same rate of interest but one pays interest more frequently, that account compounds the interest more frequently and will have a higher AER.