Savings Guide

Savings bonds – a basic guide

By Madeline Thomas editorial@consumerchoices.co.uk

Banks and building societies are offering more and more enticing savings bonds with headline-grabbing rates. But are there any downsides? (18/2/09)

The Bank of England base rate is at an all-time low of 0.5%, yet banks and building societies are offering apparently attractive savings bonds with headline-grabbing rates.

They are doing this because financial institutions still need good quality savings to allow them to make money by lending. In the wake of the nationalisation of Northern Rock and part-nationalisation of RBS, the financial regulator tightened the rules on the proportion of quality savings compared to loans that financial institutions need to have on their books. So, in order to entice savers over the threshold, they’re offering some great deals.

What are savings bonds?

Savings bonds offer the highest rates in the savings market, so they tend to grab the biggest headlines.

They can do this for two reasons: firstly, rates are fixed, so the banks know the maximum they will ever pay out. Secondly, savers have to lock their money away to get the rates, so the banks get the certainty of knowing how long they hold that cash for.

I wouldn't want to fix for more than one or two years at the moment

Savings bonds are offered in “issues”. Banks allocate a lump of money (the funds which the public invests) against what the markets believe will happen to interest rates over a fixed period in the future. They then earn the difference between what they make on the markets and what they offer to consumers. That is how the rate is priced. The “issue” or “tranche” is closed once that bank has received sufficient funds from consumers to cover its investment.

This explains why some bond offers are around for a long time and others seemingly disappear overnight.

There are examples of good bond deals being issued on a Friday, hitting the weekend newspaper best buy tables and closing on the Monday. Although this tends to only occur with smaller providers, such as local building societies.

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How good are savings bonds rates?

Rates of around 4% for savings bonds are not unusual at the moment.

Savers earn more for locking their money out of reach for a set period of time. They are being paid both for the inconvenience of that and for the fact that, should base rates rise while their money is still locked away, that rate may no longer be competitive.

In the market at the moment it is possible to find bonds at 5% or over, but they are for 5 year bonds.

However, locking away funds for five years could prove costly, particularly when base rates – at 0.5% - cannot realistically go lower, but could go higher, pushing savings rates up with them.

This is the danger that in 4 or 5 years’ time a rate of 5% may not be so attractive.

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How safe are your savings bonds?

People who invest in savings bonds are those – perhaps approaching retirement or already retired – who have lump sums. These are not accounts in which savers can squirrel away regular payments. That brings another issue into play – how secure are savings bonds should that bank get into financial difficulties?

The good news is that investments in institutions registered with the Financial Services Authority are covered under the Financial Services Compensation Scheme (FSCS) up to the value of £50,000 and for joint accounts the protection is up to £100,000. So, if your bank turns into another Northern Rock and you have £50,000 tucked away in a two-year bond, you will get your money back.

However, that £50,000 limit covers the whole financial group, not individual companies within it. The notable exception is Lloyds and HBOS – they are considered separately under the FSCS as they have separate banking licences. The £50,000 limit includes all assets in all accounts, so it is worth checking which financial organisations are grouped together under this scheme. Here is an at-a-glance guide:

Bank of Scotland, Birmingham Midshires, the AA, Saga, Halifax, Intelligent Finance
HSBC, First Direct
Scarborough Building Society, Skipton Building Society
Royal Bank of Scotland, Direct Line, Virgin
Santander, Cahoot, Alliance & Leicester
Bank of Ireland, the Post Office
Lloyds TSB, Chelthenham & Gloucester
Nationwide Building Society (BS), Cheshire BS, Dunfermline BS, Derbyshire BS

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Savings bonds - recommendations

In summary, if you have money to lock away, make sure the rate is at the top of the best buy tables , don’t lock it away for too long in an era when interest rates can only go up and don’t exceed the £50,000 limit in any of the groups listed above.