Money Column

Interest rates at 0.5% one year on: Where next for your mortgages and savings?

Friday 05 March 2010

By Daniel Barnes- daniel@consumerchoices.co.uk

The Bank of England yesterday held the base rate at 0.5% for the 12th month in a row.

As the financial crisis reached its peak, The Bank of England slashed rates from 5% in October 2008 to the lowest-ever rate.

While the rate was welcomed by those on tracker and variable rate mortgages, savers have suffered a difficult year.

We look at the last year of record low interest rates and what the next 12 months holds in store.

Saving rates

Savers’ income has dropped over 83% since the base rate fell from 5.75% in 2007 to 0.5%, according to figures from The Building Societies Association (BSA).

A BSA spokesperson said: “The cut in interest rates has eased the pressure for many borrowers, but it has not been without cost for savers.”

She added the low rates were also hitting new borrowers as building societies find it difficult to raise funds for mortgage lending.

Finding a deal that maintains a return over the rising cost of living can be hard though, with inflation now running at 3.5%.

David Black, banking specialist at financial research firm Defaqto, said: “Once again those hardest hit will be those who rely on savings interest to supplement their day-to-day living which will be the case for many pensioners.”.

“The paucity of most savings rates on offer means that many with spare cash will be looking to reduce their more expensive debt, such as outstanding debt on credit cards, unsecured loans or overdrafts, in preference to earning low savings rates.”

The average instant-access savings account now has a rate of 0.86%, although the best return available is 3% with the AA Internet Extra account.

Data from Defaqto show the best instant-access ISA is the Santander Flexible ISA which pays 3.5%, compared to an average of 1.37%.

Black added: “Those wishing to get the best variable savings rates really need to move their money around on a regular basis to take advantage of special deals such as introductory bonuses. Some existing accounts pay rates as low as 0.01%, so savers really need to avoid the obvious pitfalls of inertia.”

Being ready to lock away funds could really pays dividends, though.

The average interest rate of the five best easy access accounts has fallen by 0.16% to 2.86%, while the average of the best ISAs is down by 0.56% to 2.83% according to figures from moneysupermarket.

However, the average of the top 10 fixed rate savings bonds are up 1.05% to 5.04%

Kevin Mountford, head of banking at moneysupermarket, said: “There is no doubt that savers have been the biggest losers during the past 12 months, with rates dropping dramatically.

“There are still some good deals to be had though, especially if you’re prepared to lock your money away and fix the rate for a set amount of time.

“Savers really do need to be on their toes in the current market as lenders chop and change their rates. If you want the best rate then you really do need to shop around.”

The Post Office has the best deal on one-year bonds at 3.3%, while ICICI Bank is ahead on two and three-year bonds at 4.25% and 4.6% respectively and Birmingham Midshires is ahead of the pack on the four-year savings bonds at 4.5%.

Mortgage rates

Low mortgage rates have been a massive relief for many homeowners and may account for the lower-than-expected level of repossessions through the recession.

But for new borrowers and those looking to remortgage, the last 12 months have been quite a squeeze.

Although new deals are now starting to come out, there are still 434 fewer mortgages on the market than a year ago with 2716 deals available.

While the base rate has held firm, the Libor rate (the cost of lending between banks) has dropped by 1.1% to 0.64%. Meanwhile the average of the best two-year fixed rate mortgages is now 0.16% higher.

On average the rate on a 80% loan-to-value loan is 1.4% lower than a year ago at 4.91%.

The big change for mortgage over the last year was the change in attitude to standard variable rates (SVRs).

Hannah-Mercedes Skenfield, mortgage expert at moneysupermarket, said: “Traditionally lenders’ SVRs have usually been higher than the deal that was ending so consumers would have to remortgage as a result.

“Now we have a situation where many consumers are sitting on extremely low rates and have no incentive to move.”

Where mortgage rates will go in the medium and longer-term is still very uncertain.

The Bank of England is unlikely to jack up the base rate suddenly, tending to be far more cautious about changes.

Martijn van der Heijden, head of mortgages at HSBC, said: “The next few years are going to be difficult to predict in terms of mortgage rates and some volatility for borrowers may well be unavoidable.

“The message for borrowers is that if you couldn't afford an increase of up to 3% on your mortgage, you should seriously look to fix your payments.”

Research by Barclays points to interest rates returning to the more usual levels over the next five years and even heading up to 6.5%.

Ray Boulger, senior technical manager at mortgage adviser at John Charcol, explained in the short-term mortgage rates are drifting lower and the poor state of the economy means rates will hold low.

“The economic arguments continue to suggest a tracker mortgage is the right choice for most borrowers because the economy is in such a mess that very low interest rates are here for some time yet,” he said.

However, he warned the election could throw a spanner in the works, as markets may be unsettled by the upshot of a hung parliament or a weak new government without a clear plan.

“The message for borrowers is simply that no generic advice will do. The political uncertainty may mean the right choice for some borrowers is to batten down the hatches and lock into a fixed rate for at least five years, but with the difference between these and the best tracker mortgages around 2.5%, there is a big premium for the security of a fixed rate,” he said.

Which way forward?

With interest rates so low, they can only increase. The big question though is when.

In the short-term interest rates seem unlikely to move, as the economy is still struggling out of recession and the Bank of England may not want to make major changes in the run-up to an election.

The next government’s decision on tax will have a major influence on the economy and inflation, and so how the Bank of England may decide to put interest rates.

For savers, the best tactic may be to shop around for the best deals and look at fixed rate saving bonds, but the very long-term fixed rate bonds may seem like a good deal now but lose their attractiveness in five years’ time.

In the mortgage market, the decision to track, fix or stick on an SVR is tougher than ever. The best single tactic is to seek out a mortgage adviser and compare deals.