Get your savings out of the slow lane
In 2008, interest rates of 5% to 6% on savings accounts were pretty standard, and there were even accounts, such as Halifax’s regular savings account, which paid a spectacular double-digit 10% interest.
But those heady days are long gone, and statistics from the Bank of England reveal that the average interest rate for an instant access savings account was a mere 0.19% at the end of March 2009 compared with 2.86% in October 2007, while the average interest on cash individual savings accounts has dropped from 5.32% to 0.63% during the same period.
Although you can’t do much about falling rates, knowing your options and refusing to simply settle for your existing savings account will at least help you make the best of the current situation.
Your annual £3,600 cash ISA allowance should always be your first port of call. Unfortunately, poor interest rates mean fewer people are automatically topping up their ISAs or opening new ones. According to the Co-operative Bank, 13% more people will forego their ISA allowance this year compared with last year.
“There are still good deals out there,” says David Black, principal consultant for banking at Defaqto. “You can generally transfer funds, so it’s still worth using your allowance, in anticipation of the time when rates get higher again.”
The tax-free status provided by ISAs means that even with a low rate of interest they are still worthwhile. Basic-rate taxpayers save 20% on the interest they earn, while higher-rate taxpayers save 40%.
“If you’re thinking ‘I have to put money into something that’s safe’, you can’t ignore ISAs. Even if you’ve only got £3,600 in an ISA and you get just 1% interest, that’s still 1% gross as opposed to 0.8% net if you’re a basic-rate taxpayer and have your money in a deposit account,” says Bob Perkins, an independent financial adviser at Origen Financial Services.
Once you’ve used up your annual ISA limit, if you have a chunk of money that you know you can do without for a year or two, then you could opt for a fixed-rate bond. Those who put their money into a fixed-rate bond a couple of years ago – or even a year ago – will have benefited from locking into a higher interest rate.
Even today, despite interest rates being low, fixed-rate bonds tend to offer some of the more attractive interest rates for savers. However, the amount you have to put away - and how long you are prepared to lock it your money away for - will determine the rate of interest you earn.
Opting for a fixed interest rate at the moment - when the Bank of England base rate is so low - might not be the wisest move, as rates on new accounts could improve later in the year.
“Fixed-rate accounts are a good idea, but the downside is that you’re still not looking at a brilliant rate; if interest rates go up you’ll be saddled with the same relatively low rate,” explains Perkins.
Also, if your circumstances suddenly change, you won’t be able to access your money or, in the rare cases where it’s possible, you’ll incur a heavy penalty. Some accounts don’t allow any early access to the money unless the account holder dies or is declared bankrupt.
Regular savings accounts
If you haven’t got a large deposit, but are still happy to put your money away for a set period of time, try a regular savings account. They offer some of the better interest rates on the savings market, and while you often have to lock your money away for a year, you can pay in as little as £10 a month.
You can withdraw money from a regular savings account, but if you do so you’ll receive a lower level of interest. Some accounts also have a limit on the amount of money you can put away each tax.
However, despite the restrictions, monthly savings deals are a great way to develop a regular savings habit and allow you to slowly build up a pot of money without having to lock away a large amount all in one go. If you set up a standing order straight after pay-day, then you shouldn't miss the money too much.
Notice accounts are also helpful if you want to train yourself into healthier saving habits. “If you’re one of those people who is liable to go out and spend all your money, then notice accounts have an advantage,” says Black.
Savers usually need to give 90 days’ notice to withdraw money from a notice account, so opting for one of these is less of a long-term tie than a fixed-rate bond, and the required deposits are lower too. But of course the interest rates are not fixed.
However, there’s no point choosing a notice account if you then need to withdraw money before the notice period, as you will end up losing the ‘extra’ interest. So if you need to dip into your savings, an instant access account makes more sense.
Traditionally, because of their lower interest rates, instant-access accounts have been overshadowed by notice accounts. But the current economic uncertainty means instant-access accounts are more popular as most people prefer to be able to reach their money.
Lately, the gap between the rates offered for instant-access and for notice accounts has also narrowed. “There’s no real incentive to go for a notice account – as a general rule there’s not a lot of difference between them,” says Black.
Most rates usually last a year and then drop significantly, so only go for these accounts if you’re willing to switch to another account once your bonus rate has come to an end. “Take advantage of the offers but know when it’s time to jump ship, as banks tend to rely on the inertia of their customers,” recommends Black.
Make a note of when the rate ends – and also check the terms and conditions as some providers only allow three withdrawals in a year or you lose the bonus.
Chopping and changing isn’t for everyone though, and you might do better to look for consistency over headline rates. Moneyfacts’ savings consistency survey looks at the performance of savings accounts over the last 18 months and three years to give customers an idea of the bigger picture.
“With so many changes to rates going on in the market, it’s difficult to know where to move your money to,” says Michelle Slade, an analyst at Moneyfacts. “An account that tops the best buys one minute may see its rate greatly reduced the next.”
Nearly four in five of the most consistent accounts in the survey are offered by building societies. Principality Building Society, for example, manages to get three of its products in the consistency tables over the last 18 months.
“They may not be the best buy rates, but had you left your money with them for 18 or 36 months, you would have achieved the best rate of return,” says Slade.
If you’re still looking for a good rate, you could get a better one by opening a savings account at the same bank you hold your current account with.
Finally, if you’re a homeowner and have a chunk of savings to put away, why not consider an offset mortgage?
The way offsetting works is that your savings account and mortgage are combined so that the savings are deducted from the amount you owe on your home. You will then only be charged interest on the difference. “If you have £2,000 in savings and an £80,000 mortgage, your total mortgage is £78,000,” Perkins explains.
Basically, you are paying less interest on your mortgage, so even though your savings aren’t earning interest, the old premise of clearing debt before savings rings true.
Higher-rate taxpayers will also benefit because the usual 40% wipeout on their accrued interest in a savings account doesn’t apply with an offset scheme. So, if you have already used up your ISA allowance, this could be a good option for you.
“You need a reasonable level of savings, so these are great for higher-rate taxpayers and buy-to-let landlords,” says Black.
Remember, however, whatever type of savings account you choose, only £50,000 of your money with any one provider is protected by the Financial Services Compensation Scheme. If you have larger sums than that, make sure you spread your savings out.
A savings account on which the account holder is required to give a period of notice before making a withdrawal or face a penalty, usually a loss of a specific number of days’ interest or pay a fee. Notice periods of 30, 60 or 90 days are common. These accounts usually pay higher than average interest rates and require large initial deposits (£1,000 minimum) so the notice period and penalties are there to discourage withdrawals. Some of these accounts will only allow a certain number of withdrawals a year.
A way of combining a mortgage and savings so the savings “offset” and reduce the mortgage. Rather than earning interest on savings, the savings reduce the mortgage and the interest paid on the borrowing, so savings are effectively earning interest at a higher rate than most mainstream savings accounts will pay. They are also tax-efficient, as savers avoid paying tax on interest that their deposits would otherwise have earned. Offset mortgages offer the disciplined borrower a great deal of flexibility, as overpayments can be made to reduce the term or monthly mortgage repayments, which can save thousands of pounds in interest payments over the mortgage term.
Regular savings accounts
The attraction of these accounts is the high interest rate they pay. They require customers to deposit money each month, without fail. They come with a number of restrictions, such as monthly deposit limits, no one-off lump sum deposits and restricted withdrawal facilities. Although they are marketed with impressive-looking rates, it’s important to remember that as your money builds up gradually, your overall return will be lower than if you’d deposited a lump sum.
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.
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.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
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.
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.