How to compare savings accounts
With so much chatter in the media lately about rising interest rates, you might assume this is a great time to be saving. In November, the Bank of England delivered its biggest interest hike since 1989, setting a base rate of 3%. Since then it has jumped again to 3.5%, and there are predictions it will rise above 4% in early 2023.
However, the increased cost of living, our current energy crisis, and the impact of interest rates on borrowing mean it’s not quite so simple for savers. Indeed, for many households in the UK putting money away for a rainy day just isn't an option at present, with finances already stretched.
For those who are in a position to set cash aside, the following post may help untangle what these issues mean for your money, explain some terminology, and give you greater confidence to compare savings accounts to find the best for your circumstances.
Why are interest rates going up?
How do the interest rate increases affect me?
How do I compare savings accounts?
What’s the difference between an ISA and a savings account?
Why are interest rates going up?
The short answer is to control inflation, which is basically the rate of increase in prices over a given period of time. Think of it as the difference between how much a basket of goods will cost one year, compared to the next.
UK inflation figures show prices have risen 11.1% in the year to October 2022 – the highest inflation for 41 years, according to the Office for National Statistics. This has been largely driven by energy and raw material costs, Brexit, supply issues, particularly in the transport sector, and the war in Ukraine.
If prices are high, wages decrease in value and households get less for their money. Raising interest rates, however, acts like a brake on these soaring prices. It makes borrowing more expensive and saving more attractive. In theory, this means people will spend less, which should reduce the demand for goods and services. It means the prices of those things tend to rise more slowly. In some cases, shops might even reduce the cost of goods to encourage people to get buying again.
How do the interest rate increases affect me?
Because interest rate rises affect borrowing as well as saving, most people will be impacted in some shape or form.
One area that gets lots of attention is mortgages. Higher interest can mean more expensive monthly repayments. If you’re on a tracker or variable rate deal you might already have noticed this. The BBC reported that the Bank of England’s decision to push interest rates from 2.25% to 3% in November meant those on a typical tracker mortgage would pay about £73.50 more a month, while people on standard variable rate mortgages were looking at a £46 jump. The cumulative effect of interest rate hikes from December 2021, however, makes the difference even starker. Average tracker mortgage customers are now paying about £284 more a month, and variable mortgage holders about £179 more.
Even if you haven’t got a mortgage at the moment, you might be looking to buy a property soon. High interest means you’ll have to pay a lot more for a home loan now than 12 months ago.
Other loans may be similarly affected, from credit cards to bank overdrafts. Secured loans with a variable interest rate, such as some car loans, will follow base rate changes, and this will mean higher repayments. However, changes may take some time to take effect, and it is up to the lender whether they want to impose them.
If you’re currently paying off an unsecured personal loan, you will likely be on a fixed interest rate, which means your repayments will remain unchanged. You can read more about personal loan interest rates here.
Are savings rates going up?
In theory, the savings account high interest deals being offered now should be the best in years.
However, it’s not quite so simple because even with higher rates your savings will struggle to keep up with soaring inflation. In real terms the value of cash savings is falling. When the price of goods is rising faster than interest rates, your savings don’t have the same spending power, i.e. they buy less.
Another thing to bear in mind is that banks and building societies are under no obligation to raise savings rates. Even if they do, you might be waiting months, and even then if might not be the full rate rise.
For this reason, take time to shop around before you open a savings account. A savings account rate of interest with one bank may not be the same as with another, so it’s worth doing your homework before signing up for one.
If you already have a savings account, don't assume your provider will automatically pass on the rate rise to you. If they choose not to, you may consider switching to one that does. In the past, you may have thought that the difference in rates was too low to make the effort, but this no longer holds true. Even if it feels like a hassle, the benefits could be well worth it. Additionally, if you are thinking of switching bank accounts you could, as part of your search criteria, see what interest rates other banks are offering.
How do I compare savings accounts?
It’s not just a case of finding the savings account with best interest rate. How much you plan to deposit, when you might need the money, and who or what you’re squirrelling the cash away for are just some of the things to think about when you compare savings accounts:
Make sure you can access the money if you need to
Easy access accounts usually let you withdraw savings whenever you want, but some may limit the number of withdrawals you can make in a year. Find out first.If you don’t need your savings straightaway, a fixed-rate account could pay higher interest in return for keeping your money in an account for a set period of time. Be warned: if you take your money out before then, you could be penalised and miss out on higher interest rates if they rise during the savings term.
- Keep an eye on the Bank of England
Usually fixed rates are higher than easy access accounts. However, if the Bank of England increases the base rate further, this might not be the best time to tie up your cash in a longer-term fixed-rate savings account. Shorter-term savings accounts may be a better bet. - Look out for limits on how much you can save
Regular saver accounts, for example, are designed for putting away a certain amount every month, usually between £200 to £500, rather than large lump sums. The maximum you can save will vary between providers. - Ask yourself if you’ll mind switching accounts
Some savings accounts offer temptingly high interest rates – but only for a limited period. If you’re confident you’ll remember to switch when the top rate falls, then you could choose one of these accounts. If that sounds too much of a bother, your comparisons should focus on savings accounts that offer a decent but stable rate of interest. - Don’t overlook current accounts
Some current accounts pay a higher rate of interest than savings accounts. Check for terms and conditions though – you may only get interest on the first £1,500 or so. - Specialist accounts might offer better deals for kids
Savings accounts aimed specifically at under-18s can be a great way to teach kids good money management skills. Though similar in set-up to adult accounts, some beat their grown-up counterparts when it comes to rates. - Don’t feel limited to just one account
If you can’t decide between the benefits of two or more accounts, there’s no stopping you spreading your savings between them. You could put £1,000 in the top rate easy-access account, and the rest of your deposit in a fixed savings account which you don’t need to get your hands on so soon. - Think green
If a bank or building society’s eco credentials matter, see if they will use your savings to help fund green initiatives. Note, however, that the trade off may be lower interest rates.
What's the difference between an ISA and a savings account?
It mainly boils down to tax. If you’re a UK taxpayer, you’ll probably have to pay income tax on the interest you earn on your savings above a certain threshold. This threshold is called the personal savings allowance (PSA). At the moment, people paying the basic rate of income tax can earn £1,000 in savings interest per year without paying tax on it. For higher rate taxpayers, this drops to £500 (additional rate taxpayers don’t get an allowance).
With an Individual Savings Account (ISA), however, all the interest you accrue is tax-free.
Until recently, the tax-free benefits of ISAs weren’t relevant to some savers as the interest they earned on their money didn’t exceed the PSA. Now interest rates have started to rise, however, they may become a more attractive option as savers will be more likely to reach the £1,000 threshold.
There are a few other things to bear in mind when comparing savings accounts with ISAs. Firstly, ISAs tend to pay a little less than normal savings accounts – but not always. Shop around before making your decision.
Secondly, the interest in an ISA doesn’t count towards your PSA, so you can still have your full £1,000 or £500 allowance in another savings account. For bigger savers and higher earners, then, a cash ISA could be a sound decision.
Finally, there are limits on how much you can put in ISAs each year. For the 2022-2023 tax year, which ends on 5 April, this is £20,000. Also, until recently you couldn’t withdraw money from an ISA and put it back in without losing its tax-free status. Currently, if you have a flexible ISA, you can make withdrawals and replace what you take out. However, you need to find out how many withdrawals and deposits you can make beforehand, as not all ISAs are the same.
Final thoughts
Although rising inflation is eroding savings, in difficult economic times it is always wise to look after your pennies. Learning to budget better can be a great way to do this, as can putting money in a savings account. Higher interest rates mean there are some competitive deals around. Readers who already have one of these accounts should check that their provider has passed on the rate hikes or else consider switching.
Before making any decision, it’s always best to compare savings accounts thoroughly. Don’t just rely on the most attractive headline rate – really do your homework to make sure the account is tailored to the amount you’ll be putting away and the timeframe you have in mind.
Remember, too, that rising interest rates have a knock-on effect on credit costs. If you’ve got outstanding loans, it might make more sense to pay these off first before saving.
If you’re still not sure what to do with your money, read our ‘Should I open a savings account’ blog for further details about different types of accounts, what they each offer, and some alternatives.