Batten down the hatches as the storm clouds grow

Published on Saturday 20 September 2008 14:54

Mortgage bills, inflation and unemployment are all on the rise, so it's time to protect yourself, says Teresa Hunter

HOMEBUYERS should this weekend be bracing themselves for soaring mortgage bills as lenders push up rates on the back of higher money market interest.

Libor, the rate at which banks lend to each other, ended the week at 6%, the highest level since April. Yorkshire building society is expected to raise its deals by 0.3% over the next few days, with others following hard on its heels.

Its Accord subsidiary has pulled all its special deals along with Bank of Ireland, which has also suspended its better rates.

Turmoil in the housing market comes after a week of bad news on almost every front. Inflation and unemployment soared last week, while activity in the housing market tumbled by more than a third.

Unusually, as mortgage costs rose, returns to savers were also cut, while pensions and other investments were hit hard by reeling markets.

It's time to batten down the hatches.

Mortgages

If you have access to a competitive mortgage offer then do the deal now before it is pulled.

You can still borrow 90% of the value of a property with the Yorkshire for 5.89% with a 495 fee, and the rate is even lower if you have more equity. But these rates are due to disappear soon. You can borrow over two years with the Skipton at similar rates although the fee will be slightly higher.

Over three years, with a 15% deposit, the Newcastle is charging 6%. If you are borrowing 75% then the Bank of Scotland is charging 5.65% but it has a 1,499 fee. With a 40% deposit you can borrow at 5.54% with the Woolwich with a 995 fee.

Savings

There was precious little good news on the savings front, although Royal Bank of Scotland launched a new range of accounts late on Friday. It launched a two-year bond paying 6.6% on deposits of more than 10,000. It also has a new bonus cash Isa account paying 7.25% if you transfer 25,000 across. On smaller deposits the rate falls in tiers to 6.25% on between 1 to 2,999.

Fixed rate bonds were paying some of the highest rates ever seen until recently but over the past week at least 30 have slashed returns. The best returns are now largely available from banks which are registered overseas. For example Icici Bank is paying 7.2%, First Save 7.1% and Anglo Irish 7.05%.

Although investors still technically receive the same 35,000 protection on their savings, they may have to appeal to an overseas bank first for the first tranche of support. This process has not yet been tried or tested.

Protecting against inflation

Inflation reached 4.7% in august and looks set to hit 5% over the coming months, making it more important than ever to protect your savings against the ravages of rising prices.

A higher rate taxpayer must earn 7.83% on his nest egg if it is to maintain its value, which is impossible to do in an ordinary savings accounts. The position is easier, although only slightly, for basic rate taxpayer who need to earn 5.88% (see best buy savings tables).

Apart from that the best options are:

National Savings index-linked certificates

These pay 1% over the retail prices index of 4.7% and they are tax-free but you have to be prepared to lock your money up for three or five years, although withdrawals are possible after the first year.

NS&I estimates that at current levels of inflation, certificates are worth 9.7% to a higher rate tax payer and 7.25% to standard earners.

Minimum investments are 100 with 15,000 the maximum. Encashments within the first year of investing don't earn any index-linking or extra-interest but after that you can cash them in any time and will be paid index-linking and extra interest for each complete month you've held them.

Index-linked gilts

Another way to protect against inflation over the longer term is via index-linked gilts. These are issued by the Government at regular intervals, and can be bought at issue and held to redemption or traded during their term like any other investment.

They pay a small interest, known as a coupon, six-monthly, which is taxed as income, although the final maturity is free from capital gains tax. Both the income and capital return is index-linked.

Recent issues fixing the return to 2022, for example, have promised to pay 1.3% on top of inflation with a one-and-seven-eighths annual coupon.

You can buy gilts via banks, stockbrokers, the Government's Debt Management Office or in gilt funds.

However, financial advisers believe that the enormous demand for index-linked gilts currently makes them too expensive.

Index-linked building society accounts

The Leeds society has an account paying 2.5% above the retail prices index, currently 4.8%, while the Britannia offers a two-year bond paying 1.75% over RPI.

Unless wrapped in a tax-free Isa, unlike NS&I savings certificates these will be taxed at your highest rate.

Index-linked pensions

Those planning retirement are particularly nervous about inflation, and it is possible to shelter your pension from price rises via an index-linked annuity. However, these are expensive and will cut your initial retirement income significantly, as much as by half.

For example, a man aged 60 with 100,000 pension pot could buy a flat pension of about 7,000 per year. However, if he wants to index-link it he will only get about 4,000 at outset. In very rough terms, you need to live 18 years after retirement to be better off with an index-linked annuity.

Better ways to boost your retirement income are to make sure you maximise the potential of any health problems, via an impaired annuity, delay buying an annuity until the latest possible moment, and opt for a 3% annual escalator rather than guarantee of index-linking.