Options in a low interest rate environment
Rock bottom interest rates are tough on savers. Clare Francis, Director of Savings and Investments, explores what options are available in today’s low interest rate environment.
What you’ll learnClick to toggle accordion What you’ll learn
Why it’s important to always have some cash savings readily available.
Why, if you are prepared to accept the risks involved, you may want to consider investing.
How an offset mortgage could help you pay off your mortgage faster.
With interest rates at historic lows, it’s a really difficult time for savers. However, there are things you can do to ensure your money is working as hard as possible for you.
Bear in mind that if you owe money on credit cards or personal loans and are paying more in interest than you are earning on your savings, it can make sense to pay those debts off before building your savings further.
Consider fixed rate accounts
It’s important to have some money in an easy access savings account in case something unexpected happens. But, if you have additional money you can afford to lock away for a while, you may be able to earn a higher rate of interest with a fixed term deposit bank account from a bank or building society, usually known as a fixed rate bond.
Remember, however, that there will usually be a penalty, often loss of interest, if you want to withdraw your money during the fixed rate period. The length of time you need to lock your money away for varies as bonds are often available for periods of between six months and five years, so you can choose a term that best suits you.
It’s also worth noting that fixed rate bonds are only really suitable if you already have some savings as they often only allow lump sum deposits to be made at the time the account is opened.
You could also consider flexible savings bonds. These are similar to fixed-rate bonds, but you have some access to your money, if you need it.
As a result of the Personal Savings Allowance (PSA), which came into effect in April 2016, basic rate taxpayers (20%) can earn up to £1,000 in interest tax-free this tax year, while higher rate taxpayers (40%) can earn up to £500 in interest tax-free. Additional rate taxpayers (45%) are not entitled to any Personal Savings Allowance (PSA).
Think about investing
If you are happy to take on additional risk, you may want to consider investing. Assets such as shares, government or corporate bonds, or commercial property have the potential to produce higher returns than cash deposits over the longer-term.
However, this is not guaranteed and the value of your investments could fall as well as rise, so there’s also the risk that you could get back less than you invested.
Remember too that you’ll need to be in it for the long run – investments should be held for a minimum of five years, but preferably longer.
The aim is that the investments you put your money into will either provide you with an income or increase in value over time, or both. Spreading your money across lots of different types of investments can help you manage risk, as it evens out the size of your losses and gains.
One of the simplest ways to invest is through funds, which are a type of collective investment scheme where your savings are pooled together with money from other investors, and used to buy a group of assets.
So for example, if you invested in a FTSE 100 Tracker fund you would have exposure to every company in the FTSE 100 index.
As well as offering an easy way to invest in multiple organisations, funds also help spread the risk because whether the value of your investment goes up or down is not dependent on the performance of a single company.
For example, if you are investing for income, you might choose to invest in equity income funds. These invest in the shares of dividend-paying firms, in other words companies that share their profits with their shareholders. Bear in mind that dividend payments are not guaranteed and companies can cut or cancel their payout altogether if they find themselves in financial trouble.
Be prepared to do your research and always consider your investment options carefully. If you’re unsure, make sure you seek independent financial advice.
Make the most of tax-efficient ISAs
Making use of your annual ISA allowance can also help boost your savings and investments as returns are tax-free.
This tax year (2017-18) you can put up to £20,000 into tax-efficient ISAs. You can split your allowance between a cash, investment, innovative finance and a lifetime ISA.1 However, with a lifetime ISA, you can only pay in up to £4,000 of your £20,000 allowance.
You can put your money into a combination of these if you want, but you can only pay into one of each of these ISAs each tax year. There’s no income tax to pay on the interest you earn from a cash ISA, which makes them particularly attractive for those with savings income in excess of the PSA.
There’s also no income tax to pay on the interest you earn from peer-to-peer lending platforms if you invest in an Innovative Finance ISA, and you don’t pay income tax, tax on dividends or capital gains tax (CGT) on any returns from investments held with an Investment ISA or a lifetime ISA.
Remember that tax rules can and do change over time. They could be amended or abolished. Also, the benefits to you of any favourable tax treatment depend on your individual circumstances which may change over time, as well.
Overpay your mortgage
Regularly overpaying on your mortgage can shave years off your mortgage term, leaving you mortgage free sooner and potentially saving you thousands of pounds in interest.
Mortgage lenders often allow customers with a fixed-rate mortgage to overpay up to 10% of their mortgage balance each year. Tracker and variable-rate mortgages are usually more flexible with many having no restrictions on the amount you can overpay.
Don’t make any assumptions though because you may incur an early repayment charge if you exceed any limits on overpayments. It’s therefore important to check your own mortgage terms and conditions, and contact your mortgage lender if you’re unsure.
Use an offset mortgage
Offset mortgages are another option worth considering. They enable you set your savings against your mortgage, so you can pay off what you owe more quickly, but still retain access to your savings.
Instead of earning interest on your savings, you can either choose to bring your monthly payments down or reduce the amount of interest you pay on your mortgage debt.
For example, if you had a £200,000 mortgage and £50,000 in savings offset against it, you could opt to have your monthly repayments recalculated and based on a £150,000 loan.
Alternatively, you could keep your repayments as they are and use your savings to reduce the amount of interest you pay because you’d only be charged on a £150,000 debt as opposed to £200,000. By doing this, you are effectively overpaying every month which enables you to clear your mortgage more quickly and save thousands of pounds in interest.
Bear in mind that offset mortgage rates tend to be slightly higher than the rates available on standard mortgages.
Rising house prices have made property a popular option for investors in recent years. And if you have a significant amount of savings, you may want to consider buy-to-let either purchasing a property outright or using your savings as a deposit and taking out a buy-to-let mortgage.
Returns are available from both capital growth, through rising house prices, and rental income. However, neither of these can be guaranteed. House prices can fall, and your rental income might be exceeded by outgoings, so you need to do your sums carefully before going ahead.
Also, be aware that a number of tax changes are being introduced on property investments which could significantly affect the annual profit you make after tax. Also, not only is your rental income taxable, as it is not your principal residence, when you come to sell your property and gains would be subject to CGT.
And remember, your property may be repossessed if you don’t keep up with the repayments on your mortgage.
1 Barclays does not offer an innovative finance ISA or a lifetime ISA