Interest rates on Cash ISAs are terrible right now. So where else should you be looking for a decent return on your money?
It’s ISA season but looking at the dire interest rates available, you wouldn’t know it.
Providers are dropping rates almost daily, with Leeds Building Society the latest, pulling its leading one-year fixed rate ISA paying 1.90%.
Usually around this time of year lenders are falling over each other to launch market-leading Cash ISAs before the new financial year kicks in.
But there are other options available, such as peer-to-peer saving , which can offer12% interest, and even current accounts offering 5%.
Savers may even look towards the stock market in search of getting a better return.
The poor rates on Cash ISAs
Savings rates are pretty dire at the moment.
The Bank of England Base Rate, which has been at a record-low 0.5% for five years now is partly to blame as well as the Government’s Funding for Lending scheme (FLS), which has given the banks access to cheaper money, so they no longer have to rely on customer deposits.
This table from Moneyfacts.co.uk demonstrates the average rates on offer compared to a year ago.
|
Cash ISA account |
Average rate 26th March 2013 |
Average rate 26th March 2014 |
|
One-Year Fixed-Rate Cash ISA |
1.95% |
1.59% |
|
Three-Year Fixed-Rate Cash ISA |
2.28% |
2.04% |
|
Five-Year Fixed-Rate Cash ISA |
2.69% |
2.63% |
ISAs are a great way to avoid paying unnecessary tax and this year you can put away up to £5,760 in cash. But as rates are so poor, many people are wondering whether there's any point.
However, it’s not all bad news as there are some other vehicles to use if you’re in search of some extra income.
Peer-to-peer lending
Peer-to-peer websites are platforms you can use to get a better return on your money.
These websites work by connecting those with savings willing to lend with borrowers in need of a loan. And as the middle man (the bank) is cut out, each side tend to get much better rates.
Funding Circle, for example, allows you to lend your money to creditworthy UK businesses and is currently returning an average of 6.10% on investments.
RateSetter, which allows you to lend money to other individuals, is offering an average 5.7% return on five-year terms.
Meanwhile Zopa has introduced a price promise which means your investment, which gets lent to multiple individuals, is guaranteed to earn a rate of 5%.
TrustBuddy, which puts you in touch with people in need of short-term loans, is offering an impressive 12% return. Read more about it in: TrustBuddy: peer-to-peer lender offering 12% returns opens up to UK investors.
Of course, the average returns these sites claim don't always include the fees, so make sure you read the small print first.
Even so, the returns far outweigh those on offer from Cash ISAs. So why aren’t more people signing up?
Risk is a big factor as currently peer-to-peer websites aren’t regulated by the Financial Conduct Authority (FCA) which means if they do go bust, you could lose your money. But this won’t be the case for long as regulation will come into force from 1st April.
This will require peer-to-peer companies to hold a minimum £20,000 buffer to protect against financial shocks. This capital requirement will increase to £50,000 from 1st April 2017. As well as this new requirement these companies will have to show detailed plans of how loan contracts would be fulfilled if the company went bust. Read more about in: Regulator shakes up peer-to-peer and crowdfunding sectors.
Peer-to-peer investments could also gain tax-free status when it is included in the new ISA.
You can find out more in our article - What is peer-to-peer lending?
Current accounts
Another alternative option for savers is to look at using a current account, which pays a steady rate of interest.
Nationwide’s FlexDirect, for example, pays a market leading 5% on balances up to £2,500 for 12 months, which is far better than what you can get with a traditional savings account at the moment.
TSB's new Classic Plus, also pays a market leading rate of 5%, but only on balances up to £2,000. However, unlike Nationwide's FlexDirect this rate doesn't drop away after 12 months.
Clydesdale Bank and Yorkshire Bank’s Current Account Direct comes with 4% credit interest on balances up to £3,000 until March 2015.
You can also get a rate of 4% over at Lloyds. The new Club current account offers 4% on balances between £4,000 and £5,000. However, you will need to credit the account with at least £1,500 a month to avoid the £5 monthly fee the account attracts.
While the Santander 123 Current Account offers 3% on balances between £3,000 and £20,000, although you will need to pay £24 a year for the account.
The drawback here is you might need to switch your current account, but it’s worth it if you want the interest rate.
Stocks and shares ISAs
Instead of putting up with dismal rates on Cash ISAs, you could try your hand at the stock market with a Stocks and Shares ISA. The allowance for this year is £11,520 (though this falls if you invest in a Cash ISA as well) and any returns will be tax-free.
Two key questions to consider before going down this route are what your attitude to risk is and in what time-frame you’ll need the cash back. As a rule of thumb most experts say you need to leave your money invested for at least five years if you want to see a return so if you need the cash sooner, this won’t be for you.
Diversifying your investments will lower the overall risk and investing over the long-term will give your investments time to recover any losses.
If you’re not happy picking your own shares you could also go for an index-tracking fund which will track the performance of the index it’s based on.
Outstanding debt
If you have expensive debt like a credit card, personal loan or mortgage you might be better off clearing what you owe or part of what you owe before thinking about putting your money into a paltry Cash ISA.
You can find out which is the better route by calculating which costs or pays more. So if you have a debt of £1,000 and savings of £1,000 you can work out how much interest you are paying versus the best annual return you could get in a Cash ISA.
A credit card charging 16.9% for example will cost you £169 a year on a £1,000 balance. While the top easy access Cash ISA pays 1.75% annually will only get you a return of just £17.50 on a £1,000 investment. So you would be £151.50 better off if you used your savings to pay off the expensive credit card debt.
Even if you can’t clear the total outstanding like with a loan or a mortgage, by reducing the capital you’ll reduce how much interest you pay, which is likely to improve your finances quicker than the current crop of Cash ISAs.
However, with loans and mortgages, remember to watch out for early repayment charges, as these can negate any benefits.
More on savings:
The best fixed rate savings accounts