How to win when interest rates are low

Interest rates have been at rock bottom for 18 consecutive months now, spelling misery for savers. Borrowers are faring better but millions of people are failing to reorganise their finances to maximise the benefits in this low-rate environment. We look at what savers and borrowers should do…

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The Bank of England’s announcement that it will keep interest rates on hold for September should come as no surprise. But the decision is significant as it marks a full 18 months that base rate has remained unchanged at 0.5%.

However, the fact that nothing is happening to interest rates should not be a signal for consumers to do nothing also. Regardless of whether you are a borrower or a saver, the time to assess the impact of interest rates on your finances is right now.

Mortgage time bomb

For the past 18 months, borrowers on tracker rate mortgages and those who have come to the end of a deal and landed safely onto their lender’s standard variable rate (SVR) have been laughing all the way to the bank. Some SVRs, such as Cheltenham and Gloucester’s, for example, are still right down at 2.5%.

The trouble is many homeowners have become accustomed to these much lower mortgage repayments and, of course, there is only one way that interest rates, and lenders' SVRs, are going to move – upwards.

Even the effect of an SVR rising to a longer-term norm of, say, 5.5% could be crippling to the most flexible household budget.

For example, a £200,000 repayment mortgage taken over 25 years would cost £1,228 a month to service at a rate of 5.5%. But borrowers currently enjoying an SVR of 2.5% pay just £897 a month for the same loan. This means they would have to find an extra £331 each month to keep up repayments at the higher rate of 5.5%.

It’s your lender’s call

Worse still, it’s a lender’s prerogative to hike up its SVR whenever and by however much it wants to – even if Bank base rate stays put. According to figures from moneysupermarket.com, the average SVR has risen from 4.68% to 4.76% since the start of the year, despite no change in base rate.

“Borrowers on variable rate mortgages have definitely been in the right place for the last 18 months but the message is: things can change,” says Hannah-Mercedes Skenfield, head of the mortgage channel at moneysupermarket.com “Now could be the calm before the storm, so if you can’t afford a rise in your monthly repayments, take action.”

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Taking shelter with a fix

The only real way to do this is by switching your mortgage to the shelter of a fixed rate deal. As ever though, the cheapest fixes are reserved for those homeowners with a large deposit.

Santander, for example, is currently offering a two-year fixed rate mortgage priced at 2.75% but the deal is only available for a minimum 60% loan to value. The fee, at £1,995, is pretty hefty too and will have to be factored into the low rate.

If you were looking to take shelter for longer, HSBC is offering a fix of 3.95% over five years with the small fee of £599. However, applicants will, again, need a 40% down payment.

Borrowers with 25% equity should look at Principality Building Society’s 2.79% two-year fix with the slightly lower fee of £1,499.

If you only have a 10% deposit, the best two-year fixed is courtesy of Yorkshire Building Society priced at 4.95% with a £995 fee. Be aware, this is a branch-only product, so you have to be able to go in to qualify. 

Opportunity knocks

Some banks are already deliberately appealing to borrowers thinking of remortgaging to mitigate interest rate rises. Halifax announced this week rate cuts of 0.3% across its entire mortgage range until the end of 2011 for borrowers that apply between September 6 and October 3. Customers that have a current account will receive a deeper 0.5% reduction until the end of next year.

But David Hollingworth at broker London & Country, said: “The value of any discount will always hinge on how competitive the pricing was before any cut was applied. That’s why it is always vital to check a deal against the rest of the market, no matter how appealing the offer might sound.” The offer is also only available direct from Halifax and not through mortgage brokers.

If you are paying your lender’s SVR you will be free to leave at any time without paying a penalty. If you are mid-way through a tracker deal, however, you may find you are tied in and will have to stay put.

In this case, don’t panic – any rises are likely to be gradual. Instead, take different action by putting aside a contingency fund which will tide you over if and when your mortgage payments start to rise.

Forgotten savers

The past 18 months has been an uncomfortable journey for savers who have watched the returns on their hard-earned cash dwindle to almost nothing. Again, despite no change in base rate, average rates on easy access savings accounts have slipped from 2.98% to 2.72% over the past 18 months, according to moneysupermarket.com research. But it is possible to find decent rates of return if you know where to look.

If your savings are festering in an easy access account paying a paltry rate of interest, it’s time to shift them to a healthier home. The Post Office is offering a rate of 2.75% with a 1.25% bonus for the first 12 months for example, while ING Direct is offering the same rate guaranteed for the first 12 months.

Something for something…

If you renounce access to your cash by stashing it in a fixed rate bond, you will be rewarded in returns – and the longer you tie it up for, the higher those returns will be.

The best one-year bond for deposits of £500 and above, pays 2.90%, while savers can net 4.00% with a three-year bond and 4.80% with a five-year bond. All of these deals are exclusive to moneysupermarket.com from the Indian Bank of Baroda. Savers should bear in mind though, that tying up your cash for five years could mean you miss out on higher savings rates elsewhere once the base rate finally starts to rise.

The first place to save, regardless of interest rates, is into a cash ISA as you won’t pay tax on interest earned. You can save up to £5,100 into an ISA for the current tax year.

You can earn 2.80% on a minimum investment of just £1 with Principality’s Building Society’s e-Isa Issue 2. This rate includes a 1% bonus for the first year. Similarly, C&G, Birmingham Midshires and the AA all pay 2.70% interest a year on their instant access cash Isas.

Whether you are a saver or a borrower or both, make sure your money is working as hard as possible for you, and remember that interest rates aren’t going to be this low forever.

Please note: Any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct.

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