By Sarah Bridge, Financial Mail on Sunday
21:50 08 Apr 2023, updated 21:50 08 Apr 2023
Something strange is happening in the savings world. Typically, the longer you lock up your money in a savings account, the higher the interest rate you will receive. Vendors reward you for trusting them with your money for long periods of time.
But in recent weeks, more and more providers have reversed this trend. They offer the same or lower interest rates on five-year fixed-rate accounts than on one- or two-year fixed-rate accounts.
Laura Suter, Head of Personal Finance at wealth platform AJ Bell, says: ‘For the first time since 2016, average fixed-term accounts with a term of two years or more are paying less than the average for those with a fixed term of less than one year.’
The average interest rate on bonds with a fixed maturity of one year or less was 3.37 percent in February, the latest Bank of England data shows. For two-year fixed-rate bonds, the average interest rate was 2.45 percent.
Why is this happening?
Savers price their deals based on what they expect the Bank of England’s base rate to be in the future.
For example, they don’t want to pay savers five percent interest a year four years from now when interest rates have fallen to two percent.
Financial markets are forecasting that interest rates are nearing their peak and could even fall in the coming months. That’s because inflation is expected to drop sharply later this year, meaning the Bank of England won’t need to hike interest rates again to tame it.
Myron Jobson, senior personal finance analyst at wealth platform Interactive Investor, says: “It may seem counterintuitive for savings providers to offer a lower rate on longer-term fixed deals, but it underscores the belief that the cycle of rate hikes is nearing an end, with inflation forecasts predicting this year will cool down significantly.
“The need to pay a higher interest rate on savings long after interest rates have fallen could squeeze savings providers’ margins.”
How long should you fix?
Ask yourself when you next need to access your savings. You usually won’t be able to access it for the duration of a fix, so don’t lock up your money for longer than is practical.
If you don’t have to touch your savings for several years, it might be worth accepting a slightly lower rate for a longer fixed-term deposit account. That way, you can still get a good interest rate when interest rates fall sharply.
However, if you don’t agree with the current projections and think interest rates may continue to rise, it may be better to commit to a shorter term and then buy a new fixed rate contract when it expires. For savers who are unsure what to do, Laura Suter suggests a middle ground. “You could save half in a longer-term solution, invest the rest in a shorter-term solution, and take your risk on what interest rates will be when that solution ends,” she says.
Related Articles
HOW MONEY CAN HELP
What are the best tariffs?
At the moment there is very little choice between two, three and five year fixes.
For example, SmartSave is offering 4.51 percent on a one-year fix; Al Rayan is offering 4.68 percent over three years and United Trust Bank is offering 4.65 percent over five years. Atom Bank is offering 4.45 percent on its two-, three- and five-year fixed rate accounts.
What about taxes?
When taking out a multi-year fixed interest account, pay attention to how the interest is calculated. Some pay the interest annually, others pay everything at the end of the fixed-rate term. If you choose the latter, you are more likely to face a tax bill. You have to pay tax on interest earned on your Personal Savings Allowance (PSA). Property taxpayers have a PSA of £1,000; Higher rate taxpayers have £500 and additional rate taxpayers have none.
Receive interest on a multi-year fix all at once and you’re at greater risk of exceeding your PSA than if you receive it in annual installments.
If you save on an Individual Savings Account (Isa), you do not have to pay tax on interest.
Any other alternatives?
If you know you won’t have to touch your savings for at least five years, ask yourself whether you should invest instead.
In the long run, prudent investing usually yields better returns than earning interest on savings. However, you should only invest money that you do not have to spend for at least five to ten years.
Sarah Coles, head of personal finance at wealth platform Hargreaves Lansdown, says: “If you’re locking up the money for five to 10 years or more, it’s at least worth considering investing. You are taking on an investment risk that may rise or fall in value in the short term.
‘But the idea is that with a long-term balanced portfolio, you should have time to ride out swings and take advantage of more potential growth.’
Some links in this article may be affiliate links. If you click on this, we may earn a small commission. This helps us fund This Is Money and keep it free to use. We do not write articles to promote products. We do not allow a business relationship to compromise our editorial independence.
Comments are closed.