Are you saving comfortably?

The Bank of England has cut its base rate, but fewer homeowners are reaping the benefits. Why? Paul Slade and Teresa Hunter reveal how borrowers and savers are losing out in the interest rate war

Once upon a time, homeowners could rely on the lion's share of any base rate cut being passed on to them in the form of lower mortgage payments. But, as interest rates fall to historically low levels, more and more lenders are grabbing all the benefit of the cuts for themselves.

Of the top five lenders, only Abbey National passed on any of the last 0.25 per cent cut in base rate to their borrowers - and then gave them only a 0.1 per cent cut. Other big lenders argue that they cannot afford to cut mortgage rates any further, as this would mean a matching cut for their already hard-pressed savers.

Woolwich spokesman Rob McIvor says: "The further down the lending rates get pushed, the further down savings rates get pushed. It's difficult to see how much further down you could push savings rates without saying, `It's not really worth putting your money in the bank - take it out and put it under the bed instead'."

What this argument ignores is the fact that lenders take only part of the funding for their variable-rate loans from their savings account customers. Much of the cash involved comes from the money markets, a source of funds which becomes cheaper to use with every cut in base rate. Halifax, Britain's largest mortgage lender, gets about 26 per cent of its total mortgage funds from the money markets.

Ray Boulger, technical manager at independent mortgage adviser John Charcol, says: "Even if lenders choose not to cut savers' rates at all, then their cost of funds for variable-rate mortgages will still drop. The cost of whatever proportion of funding they borrow in the money markets will have gone down with the base rate."

This allows lenders to take the benefit of a cut in base rates themselves in the form of cheaper cash from the money markets; refuse to pass that benefit on to their borrowers; and present the whole exercise as a measure to protect their small savers.

It is no coincidence that Virgin Direct - which takes all its mortgage funding from the money markets - has found itself able to pass the whole of the 0.25 per cent cut in base rate on to its mortgage customers. Adrian Webb, a Virgin Direct spokesman, says: "The funding for our mortgages does not come from our savings accounts. We buy our money from the money markets and we buy it at three-month Libor [London Inter-Bank Offered Rate] or one-month Libor, which are linked directly to the base rate.

"What this shows up is the danger of taking a cheap short-term deal with lock-in penalties. People who took the deals with lock-ins probably assumed that mortgage rates would move in line with base rates. Those people are losing out."

Even where lenders have cut both mortgage and saving rates, the relationship between the two is not as simple as some lenders suggest. Abbey National's retail product director, Ambrose McGinn, says of his own company's 0.1 per cent cut in mortgage rate: "Our savings rates will move down also, but by no more than the same amount that the mortgage rates come down. Some won't be reduced at all, because they're already pretty low."

Figures from Virgin Direct make it clear that families with both savings and mortgage borrowings benefit far more from a cut in mortgage rates than they lose from an equivalent cut in savings rates.

Virgin says a family with pounds 1,000 in savings would lose just 18p a month from a 0.25 per cent rate cut. Assuming they had a pounds 50,000 interest-only mortgage, the same 0.25 per cent cut in mortgage rate would save them pounds 10.41 a month, giving the family a net gain of pounds 122.76 every year.

PS

Mortgage rates may have come down, but it is savers who have born the brunt of the recent cuts in interest rates, and are now earning less on their deposits than for the past 25 years, with returns below 1 per cent now common on some High Street accounts.

The Abbey National, Alliance & Leicester, Bristol & West,Cheltenham & Gloucester, Halifax, Lloyds TSB, NatWest, Northern Rock and Woolwich, are all among leading institutions paying less than 0.75 per cent for the privilege of borrowing your money. This means in real terms that many savers, perhaps a majority, are actually losing substantially all the time they leave their cash languishing in poorly-paid accounts. With inflation at over 2 per cent, they are not only failing to earn a decent return, but their spending power is actually dwindling.

It has rarely been more important to check the return you are receiving, and to switch accounts in pursuit of decent interest. Few institutions have yet dared to cut savers' rates even further, following the recent base-rate reduction, but their track record would suggest that few will be able to resist the temptation to trim that little bit extra, given time.

Perhaps the Abbey National has at least been honest by admitting that some rates will fall, although it has given an assurance that no accounts will cut by more than 0.1 percentage points. Doesn't sound too bad? However, some Abbey savers are already earning just 0.4 per cent after tax.

But it's not all bad news on the savings front. A slight rise in longer- term rates on the wholesale money markets has led to the launch of some attractive fixed rate deals. But before rushing in to lock up their money, savers need to consider whether this is just a temporary blip, and therefore an opportunity to be eagerly seized. Or is it the beginning of an upward swing in the interest cycle? - in which case the worst place for savers to fix is at the bottom.

Halifax economist Martin Ellis believes longer-term interest rates have been rising as recessionary fears have subsided. He says: "The markets now think the economy will recover from recession more quickly than they did previously, and inflationary pressures may be building up, which will in turn push rates up. There is also a view that we may not now join the euro as quickly as was envisaged, which removes some of the need to align rates with those in Europe."

But he does not believe this buoyancy in the money markets will last. He added: "I think it has been rather overdone. I believe we are at the bottom of the savings rate cycle or close to it, but that rates will stay there for some time."

If he is right then it could make sense to go into a short-term fix of perhaps a year, and guarantee an element of security. The Northern Rock is currently paying 5.9 per cent gross fixed until December 2000. This gives a saver a real return of 2.6 per cent, after tax and inflation. The Birmingham Midshires has a one-year fix at 5.65 per cent, the Derbyshire a two-year deal paying 5.9 per cent and the Dunfermline will guarantee 5.9 per cent fixed until 2002.

Fierce competition, which followed in the wake of new entrants to the field such as supermarkets, and insurance companies like the Pru and Standard Life, has kept some rates keen, so it pays to shop around.

Bristol & West's postal account is currently topping the league, paying 6.2 per cent gross. Pru's Egg still looks nifty at 5.85 per cent, and the supermarkets are typically returning 4.5 per cent to 5.3 per cent, depending on the sum.

Last week, the Halifax fought back with a not-bad deal for a high street account. Its new Halifax Saver Reward comes with a passbook and pays 4.5 per cent gross, provided you make no more than three withdrawals in a year. Deposit accounts are not the only option worth considering, however. Take every precaution possible to ensure that your money is working hard for you. Exploit ISAs to the full to shelter your earnings from tax. And, where appropriate, consider alternatives such as with-profit bonds, and equities.

Longer-term bond rates are also edging upwards. Bristol & West brought in two new High Rise Bonds this week, offering an average of 5.75 per cent over three or five years. The three-year bond pays 4.75 per cent in the first year, but guarantees 5.75 per cent in year two and 6.75 per cent in year three. The five-year bond starts at 4.75 per cent and escalates gradually to 7.25 per cent in year five. The Ilford-based brokers Baronsworth have picked out a new fixed rate ISA which offers 6.5 per cent for five years, or 40 per cent growth and full return of capital.

So is this the bottom of the interest-rate cycle? House prices are the joker in the pack. They continue to accelerate almost out of control in some parts of the UK, and the Bank of England may yet have to raise interest rates to choke demand. If interest rates rise, fixing at the bottom of the cycle could start to look a bit sad.

But we all need a hard rump of cash to bail us out in troubled times. And when that day comes, we need to be sure it is at least worth what it was when we put it by.

TH