Is it worth saving?

With interest rates still stuck at 0.5% and steep living costs leaving us stretched, you could be forgiven for thinking you might as well not bother saving at all.

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Even though inflation dropped from 4.4% to 4.0% this month, basic rate tax payers still need an account paying at least 5.01% to gain benefit in real terms from their savings, increasing to 6.67% for higher rate tax payers and 8.01% for 50% tax payers. No easy access savings accounts currently beat the effect of inflation and taxation.

Worrying new research by moneysupermarket.com reveals one in ten Brits has stopped saving in 2011 due to the steep cost of living, and one in five people are saving less than they used to.

Kevin Mountford, head of banking at moneysupermarket.com said; “With cuts in benefits, rises in National Insurance Contributions, the lowering of the higher rate tax threshold and the general increase in the cost of living, many Brits are feeling the squeeze. Unfortunately, savings become one of the first casualties when people have to tighten their purse strings.”

As an alternative to saving, one in eight people have decided to take advantage of low interest rates to overpay their mortgage instead.

Advantages of paying down debts

Overpaying your mortgage has significant benefits. For example, someone making overpayments of £50 a month on a £150,000 25-year repayment mortgage at a fixed rate of 4.5% would save £11,318.49 over the lifetime of their mortgage, and reduce their term by two years and six months.

And if they overpaid by £100 a month, they would save £20,148.30 over the lifetime of the mortgage and reduce the mortgage term by four years and six months.

Offset mortgages are another alternative and can help you clear your mortgage balance more quickly. These enable you to link the balance of your mortgage and any other borrowings you may have, such as credit card debts or personal loans, to money held in savings or current accounts with the same lender. The credit balances in your current and savings accounts are then offset against the mortgage balance, so that interest is only paid on the difference.

Why saving is still important

While it certainly makes sense to pay down debts while interest rates are still low, remember that in these difficult times, having a financial buffer in place is essential.

Kevin Mountford said: "Having a saving pot to fall back on to when times are difficult is vitally important, and while it may not be a priority for many people, trying to put some money aside, no matter how small, can make a real difference. In an ideal world, you should have three months' outgoings put aside for a rainy day.

"Those savers who have stopped saving because they believe rates are too low for switching to be worthwhile, are missing out on some of the best rates we have seen since base rate dropped to record lows. If you are prepared to lock away your money for five years, then you can get a rate as high as 5.00% - ten times more than the base rate."

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Where to find the best savings rates

Your first port of call when saving should always be ISAs, as returns are tax-free. This year you can invest up to £5,340 in a cash ISA.
Santander’s Flexible ISA, for example, pays a competitive 3.30% annual interest tax-free on a minimum investment of £1.The account guarantees to track 2.80% above the Bank of England base rate for 12 months, so you may want to move your money after this.

Transfers from other ISAs are not allowed.

Similarly, Barclays Golden ISA Issue 3 pays 3.25% annual interest on a minimum investment of £1. This rate includes a 1% bonus for the first year. If you don’t have a Barclays current account, you will need to apply for the ISA at a branch. This account also doesn’t accept transfers, but if you do want to move money across from elsewhere, the Nationwide e-ISA accepts transfers and pays 3.10%, which includes a 1.35% bonus until the end of August next year.  You have to open a card account with Nationwide before applying for the e-ISA.

Fixed rate savings

After ISAs, fixed rate savings accounts offer some of the best returns currently available. On Monday 18 April, Yorkshire Building Society is launching a new two-year fixed rate bond paying 3.95% interest before tax. The account can be opened with a minimum investment of £1,000 and the maximum amount you can invest is £2 million. No withdrawals are permitted during the two-year fixed rate term.

Other competitive two-year fixed rate bonds include Birmingham Midshires’ Two Year Internet Fixed Rate bond, which pays 3.85% on a minimum investment of £1, and the Sainsbury’s Finance Two Year Fixed Rate Saver account, which pays the same rate but on a minimum investment of £5,000.

Best three year bonds include Saga’s Three Year Internet Fixed Rate Savings account, which pays 4.20% on a minimum investment of £1, but is only available to UK residents aged 50 and over, and Birmingham Midshires’ new Three Year Fixed Rate Bond paying 4.10% on a minimum investment of £1.

Sainsbury’s Finance Three Year Fixed Rate Saver account pays 4.05% on deposits of £5,000 or more, and Halifax’s Three Year Fixed Rate Web Saver account pays the same rate on a minimum investment of £500, but you must first apply for the Halifax Web Saver variable account.

The best fixed rates are available to those who can afford to lock up their money for five years. Bear in mind however, that while these rates are very attractive now, if interest rates rise sharply over the next few years, they may not seem quite so appealing a couple of years down the line.

Birmingham Midshires has just launched a new Five Year Fixed Rate bond paying a market-leading 5.05% on a minimum investment of £1. Similarly, the AA is offering 5.00% annual interest on its Internet Five Year Fixed Rate Savings Account, which can be opened with a minimum investment of £1. Saga pays 4.65% on its Five Year Internet Fixed Rate Savings Account, but only to savers aged 50 and over. This account can again be opened with a minimum investment of £1.

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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