Sunday, 13 March 2011

Forget about ISAs - pay off the mortgage

Look at your interest rates, think about bankers' bonuses...and weep.

I'll get to the nitty gritty about Individual Savings Accounts in a bit but, first, the big picture.

The average interest rate earned on a tax free Cash ISA at the moment is a mere 0.43%, according to the Bank of England. Compare that to the average rate paid by UK homeowners for a tracker mortgage: 3.54%.

The difference is a whopping 3.11%. This is the amount that is creamed off by banks at our expense, to bolster their balance sheets after the banking crisis.

So consider the predicament of the retired couple dependent on savings interest to bolster a modest pension income. The couple is having to dip into savings to pay household bills because the interest is so meagre.

They are doing without, the bank is counting the profit and the bank's bosses are taking multi-million pound bonuses from the proceeds.

The 3.11% margin compares to 3.23% a year ago, 3.34% in 2009, but just 0.92% at the same point in 2008.

Now look at the latest rates being touted for Cash ISAs. If you believe the press we are being wooed with irresistible deals in advance of the the deadline for 2010-11 ISAs at the beginning of April.

AA offers 3.5%, Santander 3.3%, Barclays 3.25% and Nationwide 3.1%.

Lop off the temporary bonus included in the rate and that translates to: AA 1.85%, Santander 0.5% (!!), Barclays 2.25% and Nationwide 1.75%.

For those of you with spare cash and no debts to pay off, the mortgage especially, these rates might give pause for thought. If you are going to salt money away, you might as well do it in an account where no tax is charged on the interest.

But the rest of us have to compare ISA returns with the cost of our mortgages. As I mentioned, we are paying 3.54% on average for a tracker. The typical Standard Variable Rate mortgage costs 4.02% and the typical 5-year Fixed Rate costs 5.17%.

It is no surprise then that families have been using any spare savings to pay off their debts. Better to use your money to reduce a 4%-or-so interest burden than clock up a 0.43% gain.

The pay-off-your-mortgage strategy makes even more sense now that we face a rise in the Bank of England's base rate. We don't know precisely when it will happen, but most forecasters expect a move this year.

The increase, when it comes, will be a shock for millions of homeowners with variable rate mortgages.

There is a sub-class of borrowers who are on astonishingly low mortgage rates from before the financial crisis and others who are locked into fixed rate deals where no repayments are allowed.

But the rest should be very wary of banks bearing gifts in the shape of Cash ISAs.


  1. We are a family with two young children. My wife doesn't work (was made redundant and looks after the kids / house). I work.

    Could there be an argument to lose money on interest, if that money could be used as a safety net if I lose my job? Consequences of losing two or three hundred pounds per year in interest = low. Consequences of losing job then not having money for mortgage / bills / cost of living = high.

    Would appreciate your thoughts!

  2. People say it's wise to keep an easily accessible reserve for emergencies and an instant access ISA is a suitable place for that, though I can't say what's right for your particular circumstances.
    And some experts warn that it's a good idea to keep your emergency money in a different bank to your current account or mortgage. Banks have been known to transfer money out of a savings account to cover a deficit elsewhere.