Beware Of Interest Rate Guarantees

There's always a major catch with savings account that offer variable interest rates. You know what rate your account is paying today, but what about next month or next year?

There's always a major catch with savings account that offer variable interest rates. You know what rate your account is paying today, but what about next month or next year?

How can you make sure your fantastic best buy account doesn't start to lag behind the competition further down the line? Well, it's not easy. Even if you choose an account with a high fixed rate, there's still no way of knowing whether it will continue to beat the return available on variable rate savings in the future.

But to give you a little peace of mind over this interest rate conundrum, some banks and building societies now offer accounts with an interest rate guarantee.

What is an interest rate guarantee?

Quite simply an interest rate guarantee promises the interest you earn on your savings will never fall below a specified level. The guarantee is normally linked to the Bank of England base rate. For most accounts, the interest rate will always match or beat the base rate by a certain margin, usually for a set period.

That said, some banks offer lifetime guarantees such as Bradford and Bingley's Rate for Life account. Here the rate is guaranteed to be at least 0.25% above the base rate for the life of the account. With the base rate at 5% today, the account pays a current return of 5.25%.

But, even with a guarantee, you still won't know exactly what interest rate you'll earn because we don't know how the base rate will change over time.

One or two less generous accounts guarantee a minimum rate which is actually lower than the base rate, but the table below shows the top six accounts which can do better than that:

Top six easy access accounts with interest rate guarantees

*Minimum opening balance is £5,000 where interest is paid monthly.

As you can see, the current market-leader, Kaupthing Edge, guarantees the interest rate payable on its Savings Accounts will beat the base rate by 0.30%, at least, until 1 February 2012. Meanwhile, Bradford & Bingley Internet Saver 3 will match the base rate until 31 October 2010.

Is the guarantee worth it?

Don't think just because you have an account with an interest guarantee, you can now take your eye off the ball. True, a guarantee is nice to have and it usually gives some temporary protection that your interest rate won't fall far below the base rate. But it doesn't guarantee that your rate will necessarily remain competitive.

Take Kaupthing Edge for example. With the base rate currently at 5%, the interest rate on Kaupthing Edge Savings could be cut by 1.25% taking it down to 5.30%. This would still keep to the guarantee of base rate + 0.30% but would render the account far less competitive. Worse still, after 1 February 2012 the guarantee disappears, so Kaupthing could feasibly cut the rate as much as they like.

Of course, I'm not saying Kaupthing has any intention of doing so (at least none that I'm aware of) and up to now the bank has continued to offer best-buy rates since its debut in the UK savings market.

I do think you need to be aware of how much protection an interest rate guarantee actually provides. Putting it in context, Fool partner, Moneyfacts, claims 78% of savings accounts earn less than the base rate. That means, as it stands today, an account with a guarantee to match or beat the base rate will automatically be in the top 22% of the market.

Just remember this: Regardless of whether your savings account has a guarantee or not, you should still review it regularly to make sure you still have a good deal. You can do this easily by comparing accounts at The Motley Fool Savings Centre.