Take care when choosing a new current account, because these three nasties may be lurking in the small print.
One of The Fool's most popular financial sayings is switch and save. Of course, the whole idea behind jumping ship is to improve your lot, either through better service or superior financial benefits.
For example, we habitually encourage Fool readers to switch to a new-generation current account. That's because the old-style bank accounts which most of us stick with offer incredibly poor value for money. Indeed, five in nine current accounts (55%) pay interest at a pitiful 0.1% a year on credit balances. Thus, on an average balance of £1,000, you'd earn a paltry £1 in interest over the course of a year -- and that's before the taxman takes his cut!
Another problem with traditional current accounts is that they charge hideously high interest rates on overdrafts, and levy ridiculous penalties on unapproved borrowing. Therefore, you need to tread carefully when trawling the market for a better current account, because there are many pitfalls lurking in the small print. Here are three sneaky tricks to watch out for:
1. Short-term `bait rates'
We Brits are famously reluctant to switch current accounts. Indeed, some pundits claim that a married couple is more likely to divorce than switch banks. Thus, in order to encourage us to vote with our feet, banks offer very generous rates of interest to those customers who are willing to change over.
Sadly, these initial `teaser' or `bait' rates often don't last, and are replaced with lower rates, usually after a year. Have a look at the table below:
Current account | Teaser rate | Lasts for... | Follow-on |
|---|---|---|---|
Abbey Current | 8.00 | One year | 2.50 |
6.50 | To 31/01/09 | 1% below base rate | |
6.40 | One year | 4.25 | |
Coventry BS | 6.35 | One year | 5.50 |
Halifax | 6.17 | Indefinitely | N/A |
As you can see, the top four accounts offer great rates for a year or so, but these do fall to more modest levels. For example, a balance of £1,000 would earn annual interest as follows:
Current account | Teaser | Follow-on | Rate drop (%) |
|---|---|---|---|
Abbey Current (credit option) | 80 | 25 | 69 |
65 | 47.50* | 27 | |
64 | 42.5 | 34 | |
Coventry BS | 63.50 | 55 | 13 |
Halifax | 61.70 | 61.70 | None |
* assuming the Bank of England base rate remains at 5.75% a year
Abbey customers face the worst deal after one year, when their credit interest rate drops by almost seven-tenths (69%), from 8% to a mere 2.5%. Customers of A&L face a rate cut of over a quarter (27%); for Lloyds TSB switchers, the drop is just over a third (34%). On the other hand, Halifax HICA customers earn a high, ongoing rate of 6.17% a year.
So, if you're planning on having a long-term relationship with your new current account, then be sure to look beyond short-term teaser rates!
2. Tiered interest rates
Another trick which current accounts use is to pay a high rate of interest on balances up to a certain level. Beyond this threshold, the interest rate is generally awful, as my next table reveals:
Current account | High-rate | Interest on |
|---|---|---|
Coventry BS | 250,000 | N/A |
2,500 | 0.10 | |
2,500 | 0.10 | |
Halifax | 2,500 | 0.10 |
Abbey Current | 1,000 (new) 2,500 (switchers) | 2.50 |
The Coventry BS First account easily tops my list, because it generously pays its top rate of interest on up to a quarter of a million pounds. A&L, Lloyds TSB and Halifax pay their highest rate on only the first £2,500; Abbey has its thresholds at £2,500 for switchers and a mere £1,000 for those new to banking. So, if you plan to keep more than £2,500 in your account for an extended period, then the Coventry First account is your best bet.
3. Minimum monthly funding
Banks don't want to give their best, most delicious headline rates to any Tom, Dick and Harry. In fact, they aim to cherry-pick the finest customers from other banks in order to maximise profits from their new intake. One way that they do this is to pay high rates of interest solely to customers who deposit a certain amount each month. Here's a table of minimum monthly funding requirements:
Current account | Minimum monthly |
|---|---|
500 | |
Abbey Current | 1,000 |
Coventry BS | 1,000 |
Halifax | 1,000 |
1,000 |
Accordingly, if you don't pay at least £1,000 into your account each month (or £500 going to A&L), then you won't qualify for the high rates of credit interest shown in my first table. So, if you don't want to go back to earning a pathetic 0.1% a year while in the black, then be sure to meet the above funding requirements -- or look elsewhere!
And finally....
Thanks to a beefed-up Banking Code, it's never been easier to switch current account. Furthermore, most banks operate a dedicated switching service to make things easier for new customers.
Finally, one reader asked me whether changing current account will damage your credit rating.
The answer is: it largely depends on your personal circumstances. When credit-scoring potential borrowers, banks award extra points to those customers who've been with one bank for a long time. However, the effect of switching banks is likely to have only a trivial effect on your overall credit score. Indeed, your housing status, income and the length of time you've been in your present job will carry far more weight. So, don't let credit worries put you off from switching!
More: Use the Fool to find first-rate current accounts and savings accounts | Earn 7% If You're Over 50