With many savings accounts now offering pitiful returns, financial advisers say they have been besieged by clients asking if their money can be put to better use elsewhere.
Those looking to organise their budget and position themselves for the economic downturn have been told to address expensive debt first.
In spite of lower interest rates dragging down returns on savings accounts, some borrowers are being charged more than ever for credit cards and personal loans.
Research from Moneynet.co.uk shows that while the base rate has fallen from 5.5 per cent to 1 per cent in the past year, the average purchase rate on credit cards has increased from 16.77 per cent to 17.48 per cent. The rate charged for cash withdrawals on credit cards has risen by nearly 1.5 per cent to 25.29 per cent over the same period.
The rates charged for personal loans are also rising. “Borrowers who consolidate their loans annually will be in for a shock this year,” said Tim Moss, head of loans at moneysupermarket.com. “Last year, rates were around 6.5 per cent but they are now more like 8.5 per cent, and they could rise to 9.9 per cent over this year.”
Financial advisers concur that paying down debt is a sensible strategy. “The comparison between earning 1 or 2 per cent in a savings account and paying out 8 or 9 per cent on a loan is huge,” said Marc Ruse at Fiducia Wealth Management.
Unless it is possible to obtain a return from savings, after tax, that beats repayment rates for debt, the case for paying down debt is clear. But when it comes to mortgages, matters become more complicated.
Many homeowners are opting to use what spare cash they have to reduce the debt on their mortgage. That’s because a higher rate taxpayer with a mortgage interest rate of 4 per cent would need to earn 6.66 per cent or more from cash savings in order to be better off – impossible given current savings rates.
John Lang, adviser at at Tower Hill Associates, says customers not wishing to take investment risk should use surplus cash to pay down their mortgage, while keeping at least six months’ net income in cash. This strategy could also come in useful when homeowners come to refinance their properties as the best deals are reserved for those with large amounts of equity in their home.
But those borrowers lucky enough to have a competitive tracker mortgage that has fallen in line with the interest rate cuts could be better off maintaining their debt.
It is still possible to obtain fixed rates on cash savings accounts of 3.9 per cent from ICICI, and cash Isa rates of 3.1 per cent from Marks and Spencer, which homeowners with very low mortgage rates could take advantage of.
For those savers who have already paid down their debts and rely on the returns for income, investment in the corporate bond or equity market is becoming increasingly popular, said brokers.
“We have a number of clients who have held back but who are now dripfeeding money into the market,” observed Ruse. “They are cautious but they cannot get decent returns from cash.”
However, advisers have urge investors to weigh up the expected returns with the security of their capital.
“Those who hold cash because they neither want nor need to take risk should remember that in due course the current interest rate squeeze will pass,” said Jason Butler, a chartered financial planner.
“How long that will take is anyone’s guess, but investors need to view the current fall in cash rates in that context and avoid kneejerk reactions.”
Chris Cole at Towry Law, the financial planner, agreed. “Everything feels acute right now, but it isn’t wise to let the wider economic circumstances dictate your risk appetite. There are some OK cash rates out there, and if inflation returns, interest rates will come back.”
