The First Way – Manage Your Bank Account

Many people will have started a bank account at college: when they start work, they have to manage a balancing act in order to handle their bank account most effectively.

There are two basic rules:
1. Do not overdraw beyond your agreed limit, and
2. Make sure that you have sufficient funds to meet direct debits and standing orders.

The reasons for these two basic rules are simple: if you do not obey them, you will have a lot of hassle, you may acquire a bad banking reputation and you will certainly pay – there are cash penalties for straying beyond what you agreed with your bank. Thanks to the internet, controlling your bank account is fast and easy; as an alternative, many banks operate a telephone service.

Making Your Money Work

Once you have your bank account under control, you face the other part of the balancing act: how to make your money work for you. You may have an interest paying account, but you will quickly find that the rate of interest the bank pays you is far from generous. Your target for interest has to be that, allowing for tax, the rate you receive at least matches inflation.

The first answer is to set up a ‘feeder’ account: you agree with the bank that your basic account will be fixed at say £500 and that any excess will go into a savings account where you receive a higher rate of interest. Even that improved rate may not meet your target, so you put some money with one of the institutions named in the newspapers or on one of the internet comparison sites.

To make this set-up work, you have to keep a close watch on your bank accounts and be able to transfer money when a large payment arrives. You have to remember that it takes two or three working days to transfer a bank payment; you need to plan in advance if you go on holiday or if your job takes you away from home.

What Type of Account?

When you start to use a bank, your account will be in your name only. You may set up a joint account when you share a flat with friends; this becomes more likely when you marry or begin a relationship, particularly to handle household bills.

Example: How Safe Is Your Deposit?

Alan Dowding is especially relieved that protection is being improved for people’s bank deposits. Alan, who lives in Newcastle, had £50,000 on deposit with Northern Rock, the local bank and mortgage lender which hit problems last summer – when the rules gave cover up to £31,700 on the first £35,000. (All the first £2,000, then 90% of the next £33,000.)

Alan has since learned that the answer, with a large deposit, is to spread it among severalbanks. His first thought was Halifax and Bank of Scotland, but his accountant pointed out that these form part of the same financial group, which could mean just one amount of compensation (depending how the companies are registered).From now on, Alan plans to make deposits jointly with his wife, so that they could both make claims – or divide the cash if they want to make separate deposits.

Two issues arise: a joint account is the responsibility of you both, so the bank will look to both of you to make good any shortfall. (What lawyers call ‘joint and several’ responsibility.) Secondly, you have to decide whether cheques on a joint account have to be signed by you both or just one of you. Both signatures means that you both know what is being paid out and in, though it can become cumbersome if one of you is away a good deal. Alternatively, you can have cheques signed by either one of you: in that case, one of you will not keep up-to-date – and if it ends in tears, one of you can clear the account.

You Need a Cushion

The first step in your banking arrangements should be to create a cushion to deal with the unexpected. This cushion should be equal to three to six months’ income, and held in instant access accounts – which means that you can get hold of your money quickly and without any loss or penalty.

Nowadays, you should be able to get an interest rate which equals inflation after allowing for tax; this must be your objective when you are holding cash beyond the short term. Rates are widely quoted in the press and in search engines on the internet – you will probably find the best rates over the net.

You need to remember two things: one is that instant access does not quite mean what it says – to arrange a transfer of funds into your bank account will take a few days. The second important point you should not forget is that rates change: the bank or borrower which was top of everybody’s list drops down and for reasons of its own it stops paying attractive rates in order to attract deposits. You need to watch the comparative tables and, if necessary, move your money – which, by definition, is not difficult, but you have to make it happen.

And you will have noticed if the appealing rates quoted include a bonus, for, say, six or twelve months; after that time the rate may fall quite sharply. This simply means making a note in your diary and telephoning at the right time: you may well find you can roll over your deposit at another attractive rate.

Called To Account?

You may be one of the several millions of bank customers whose account tipped into the red over the past six years and whose bank charged a fee – either for an unauthorised overdraft or because you exceeded an agreed overdraft limit. If you are one of these, read on with care, because in late 2007 the Government’s Office of Fair Trading (OFT) dropped a large bomb in this particular pool.

Before the OFT intervened, the banks were charging what many people regarded as stiff penalties. The charges that were levied by some leading banks last year are set out in Table 1.1

Table 1.1: What You Had to Pay

Barclays

Unauthorised Overdraft - 25%

Fees and Charge -
Paid Item: £30 (Max 3 per month)*
Bounced: £35 (Max 1 per day)

HSBC

Unauthorised Overdraft - 18.3%

Fees and Charge -
Unauthorised O/Draft up to £25 (Max 1 per day)*
Paid Item: £25
Bounced: £25 (Max 1 per day)

HBOS

Unauthorised Overdraft - 29.8%

Fees and Charge -
Paid Item: £30 per day (Max £90 per month)
Bounced: £39 (Max 3 per day)

Natwest

Unauthorised Overdraft - 29.69%

Fees and Charge -
Unauthorised O/Draft £38
Paid Item: £30
Bounced: £38

*Not charged if first occurrence in six months (Source The Times early 2007)

This shows that HBOS (Halifax Bank of Scotland)charged for each bounced cheque or direct debit, with a maximum of three fees each day. It also charged a fee of £28 per month if you went over an agreed overdraft limit. (A paid item is charged when a cheque, direct debit or standing order is paid by the bank though there are not enough funds in the account.)

Many customers, spurred on by the press and consumer organisations, complained to their banks; by the time the OFT moved, several hundred million pounds had been handed back. This is how it was done:

First step: Write to the bank asking them for details of charges on unauthorised overdrafts over the previous six years. That information has to be provided under the Data Protection Act 1998 and the charge should be nominal. (Rules in Scotland are slightly different.)

Second step: Write to the bank explaining that you are a long-standing and loyal customer; you feel that the charges they have made for the unauthorised overdraft, or whatever, do not reflect the costs to the bank.

A reclaim is now off the menu, because of an agreement that no claims would go forward while the OFT’s case was making its way through the courts: at the time of writing (2008) the process was expected to take at least a year: the High Court had to give its verdict, with the likelihood that the loser would take case to the House of Lords. But you need to remember how the claim procedure works, in the event that the banks win the argument – and if they do beat off the OFT, they may be tougher on any further claims.

Remember also that you can track back six years, as allowed by the statute of limitations. If you have all your records for that time, great. If not, it will probably make sense in any case to ask your bank to give you details of any fees and charges. If the banks win, you will need this information for your claim; if the OFT wins, you will need the information to get the compensation which could then become available. The key element remains the courts’ final judgment and just how clear that proves to be. Nor is the issue as straightforward as it looks: some people argue that if big spenders go over their bank limits, that is exclusively their problem. Behind this argument is the prospect that, if the banks have to reduce charges for unauthorised overdrafts they will have to stop subsidising ordinary current accounts which, at present, are free.

You can see what could happen: if the courts, the government, the OFT, etc, feel sorry for people who paid these charges for unauthorised overdrafts and cut them back in future, that could spell the end of free banking for the rest of us.

Example: How To Move Money Abroad

If you want to move a large sum of money overseas, to buy a car or a property for example, it makes sense to use a foreign exchange broker. Some financial advisory firms also offer this service, which can save useful amounts.

For smaller sums, many people use their bank for a telegraphic transfer or to obtain an international banker’s draft. There are alternatives, especially if speed is important: you can load someone’s credit card or if you want to make a transfer there is the long-established Western Union and MoneyGram, which operates in the Post Office and Thomas Cook. You should expect to pay 5–10% extra for the cost of this service.

A modern electronic way to move money is to use PayPal, which offers competitive charges, though it may take up to a week for the funds to move from one bank account to the other. The sender and the person receiving both need to have an email address and a free PayPal account.

So You Want To Borrow?

Most of us need access to extra finance from time to time. You may also look hard at the rates charged by motor insurers and others when you want to spread payments over a year, and decide that 10% plus is not for you.

For short-term borrowing, the choice lies essentially between credit cards and a loan. The chapter on credit cards contains a stiff warning from the chairman of Barclays on borrowing – but that refers to long-term borrowing, where credit card rates are extremely expensive.

The short guide to your choice is: use credit cards if you are switched-on in terms of financial management – good at keeping to limits and good at keeping to dates. Credit cards can be especially attractive if you can overpay for even a few months of the year.

The basic borrowing tool of credit cards has to be the 0% balance transfer, and/or the 0% on new purchases; and you will remember to cost in the 2.5–3% balance transfer fee. Some cards will allow you to avoid paying interest for 10–12 months, when you can go to another card (you need to take care on using cards for purchases when you make a balance transfer: see the chapter on credit cards). So long as you are skilled in handling the date of the balance transfers and in using the right card on fresh purchases, this method of borrowing is appealing.

Credit Card Extras

Compared with loans, credit cards also offer some potentially useful side benefits. Some will give you cash back, either as a cheque or a credit against your monthly account. Many credit cards offer free insurance cover on purchases; and all credit cards give you protection under the Consumer Credit Act.

The risks in credit cards are equally clear: if you don’t pay off your balance in full each month you will be hit by a high interest rate. If you go over your agreed credit limit you will suffer a fee. And you should not use your credit card to withdraw cash – prefer your debit card.

Table 1:2 The Power of Compound Interest – How Long it Takes to Double Your Debt

Borrowing Rate:25%
Years for Debt to Double - 3

Borrowing Rate:20%
Years for Debt to Double - 4

Borrowing Rate:15%
Years for Debt to Double - 5

Borrowing Rate:10%
Years for Debt to Double - 7

Why Not A Loan?

A bank loan looks to be the simple answer: there is nothing to compete with the credit cards’ 0% balance transfers, but you can borrow a lump sum for up to 10 years and at a rate which compares favourably with those levied by credit cards.

Many loans charge a fixed rate, so repayment amounts should be consistent. This makes financial planning much easier – and you are in command of your repayment period. Setting up a loan is generally quick and simple.

Early Pay-Back Fee
The great drawback of a loan lies in its inflexibility. This appears when you want to pay back ahead of time: the majority of loans are repaid early, but this will probably bring an early settlement fee.

Two other points to watch for are the cost of payment protection insurance, which can be heavy, and precisely which percentage rate you are charged. The APR(annual percentage rate) may be less helpful than the TAR (total amount repayable) which will guide you on the cost of your loan. And the APR you have to pay may be increased if your credit rating leaves a little to be desired.

Raise Money On Your House

For people in the 30+ generation, the way to borrow medium term is through re-mortgaging. See Chapter 2 on Re-mortgaging, which has become a huge business and extremely popular.

Re-mortgaging is essentially a way of tapping into the rising value of your house and getting your hands on some of the 100% plus increase in its value which,on average, has taken place over the last ten years. Borrowing rates are much less than those charged by credit cards and generally lower than the rates on loans.

But re-mortgaging is probably not an option for the 50+ generation. Their mortgages will have only a few years to run, which means that re-mortgaging will be expensive. Even if there are a number of years left, a small mortgage also means that a re-mortgage may not make financial sense.

But for those of you 50+ there is another way to borrow on your house – and where you will not have to pay cash interest. We are living longer and the value of our houses grows steadily while living costs rise. Many thousands of people find their pension grows less adequate year by year, they need capital to buy a new car and to go on holiday, and their only major asset is the house they live in. This is why there has been a boom in equity release.

Two Ways To Equity Release

Older people in Britain are now raising between £1,500 and £2,000 million a year through equity release. The name says it all: you are tapping into the equity in your house, i.e. its value over and above any mortgage loan. Equity release schemes are operated by the major insurance companies and specialist advisers.

There are two types of equity release: the lifetime mortgage, which is the most popular, and a reversion plan, where you sell a part of the value of your house. You and your partner need to be at least 55 years old, and the terms will be better the older you are. In each case you get a lump sum, which is free of tax but which could affect your entitlement to tax and welfare benefits: you need to explore this issue before you commit. Both types of equity release are supervised by the Financial Services Authority.

No Monthly Interest To Pay

The lifetime mortgage works like a traditional-type mortgage, with one key difference – you do not pay out money by way of interest. You pay interest on what you borrow, but it rolls up until you and your partner both die or move into a care home. You should be offered the guarantee of ‘no negative equity’ – that the amount you owe will never exceed the value of your house, which is a useful defence against a possible drop in house prices.

You can see the appeal of a lifetime mortgage compared with an interest-only mortgage from a bank or insurance company: you have no cash flowing out, so you are free to use the mortgage money as you please.

Under a reversion plan, you sell part of your house – 100% if you choose – and you get a lifetime lease for your partner and yourself. The sale price, both for a reversion and a lifetime mortgage, will not be the market value of the house but a fraction, of between 25% and 40%. This is because the finance company is lending its money for an uncertain time (depending on how long you both live) which could be 20 or 30 years.

Who Is Eligible?

Most homes in England and Wales worth more than £75,000 or so will be eligible for equity release: some lenders stay out of Scotland, where the legal system is different. If you live in a flat, the lease must be long enough to cover your life expectancy by a reasonable margin.

Table 1.3: Lifetime Mortgages vs. Reversion Plans

How is cash released?

Lifetime Mortgage - You receive a cash lump sum or income by taking out a loan, secured on your home. Interest rolls up on the loan until the end of the plan.

Reversion Plan - You sell a share of your home to the reversion provider in exchange for a lifetime lease and a cash lump sum.

How is the plan repaid?

Lifetime Mortgage - When your house is sold, the loan plus interest is repaid out of the sale proceeds.

Reversion Plan - When your house is sold the reversion provider takes their share of the sale proceeds, according to the percentage share of your property that they own.

When does the plan end?

Lifetime Mortgage - When the last remaining partner dies or moves into long-term care.

Reversion Plan - When the last remaining partner dies or moves into long-term care.

Can more funds be released later?

Lifetime Mortgage - Top-ups can typically be arranged after a qualifying period. Or, you could opt for a plan where you draw down cash as and when you need it, only incurring interest on the amount drawn.

Reversion Plan - As long as you exchange less than a 100% share of your property, you can typically sell an additional share later if you want to generate extra cash.

What happens to inheritance?

Lifetime Mortgage - This will be reduced but some plans allow you to guarantee an inheritance and most plans carry a ‘no negative equity’ guarantee so you will never owe more than the value of your home.

Reversion Plan - This will be reduced, but any share of your property that you retain can be left as an inheritance and you can also benefit from a ‘no negative equity’ guarantee.

Some people have a mortgage when they decide to take out equity release – say the remainder of a 20- or 25- year loan. The equity release company will want this existing mortgage paid off, either before you sign up, or netted out as part of the overall transaction.

What Does It Cost?

If you take out an equity release plan, the important up-front fee will be for an independent valuation, which will form the basis on which the finance company lends you the money. You may also have an application fee and legal charges, which will probably be deducted from the lump sum; institutions vary in the help they will give you over costs.

One important difference between a lifetime mortgage and a reversion plan is that in the former case, you remain the owner of the house; under reversion, you are a lifetime tenant. You will be responsible for keeping your home in good shape and making sure that it is fully insured.

You can move house if you have taken equity release: you have to tell the lender and the new home will have to meet his requirements. Moving house will cost – the average cost of a move is now close to £10,000 – and if you change to a lower value property you may be asked to repay some of the money.

Taking On a Debt

Equity release is debt, secured on what is probably your biggest asset. This means that a lifetime mortgage or a reversion reduces the size of the estate you will leave to your heirs, so taking equity release should follow a family discussion.

The cheerful side of that coin is that your estate is reduced for inheritance tax (IHT), which attracts some people to equity release. You could take out a lifetime mortgage and distribute the proceeds, or some of them, among the family; if you live for seven years, those gifts will be free of IHT and the bill for your total estate will be that much less.

Living Longer Will Cost...

So what are the snags of equity release? The most obvious – from one standpoint – is that you take out a lifetime mortgage and live for another 20–30 years. This is very good for you, but the debt will have grown: if you took out a loan for £50,000, were charged interest at 6% and lived for another 25 years the debt would have reached just over £200,000.

The ‘no negative equity’ agreement will protect your estate, but the debt will make a hole in what you leave to your heirs – unless house prices have been rising faster than the interest rate you have been charged. This underlines the case for a family talk before you commit.

Table 1:4: Fixed-Rate Lifetime Mortgage

Age 60
MINIMUM PROPERTY VALUE - £88,250
MAXIMUM LOAN AS PROPORTION OF PROPERTY VALUE - 17%

Age 65
MINIMUM PROPERTY VALUE - £68,250
MAXIMUM LOAN AS PROPORTION OF PROPERTY VALUE - 22%

Age 70
MINIMUM PROPERTY VALUE - £55,750
MAXIMUM LOAN AS PROPORTION OF PROPERTY VALUE - 27%

Age 75
MINIMUM PROPERTY VALUE - £50,000
MAXIMUM LOAN AS PROPORTION OF PROPERTY VALUE - 32%

Age 80
MINIMUM PROPERTY VALUE - £50,000
MAXIMUM LOAN AS PROPORTION OF PROPERTY VALUE - 37%

Age 85
MINIMUM PROPERTY VALUE - £50,000
MAXIMUM LOAN AS PROPORTION OF PROPERTY VALUE - 44%

Note: (a) In joint applications, maximum loan is based on the younger of the two ages (b) Minimum loan = £15,000 (Source: Norwich Union.)

Example

Jack and Jean Aspinall, now in their 80s – Jack is 84 and Jean 80 – find they need extra cash to redecorate the house and perhaps have a holiday. They choose a home reversion scheme rather than a lifetime mortgage as they want to leave 50% of their house to their daughter Elspeth. Their house is valued at £210,000 and they are told they can expect to receive around £55,000 for a half-share. Jack paid the valuation fee upfront; he still has to find the legal costs, which he reckons will be about £350, and the application fee. This varies from plan to plan, but Jack is told he should expect to pay around £450.

. . . So Will A Change Of Mind

You should also appreciate that equity release is somewhat inflexible: lifetime mortgages are designed to last for the rest of your life or until you leave home to go into long-term care. If you want to repay early, you will probably be hit by an administration fee and an early repayment charge.

In the same way, you may be asked to take out a lifetime mortgage at a fixed rate of interest – which in a few years’ time could look very clever or the exact opposite. On a fixed rate, you have the great advantage of certainty so you know exactly how much you, or your estate, will have to pay. As an alternative, you may be offered a rate of interest linked to retail prices with a cap limiting the maximum rate.

Age Helps

If you come to retire say age 65 and find your income is lagging and you need more cash, then equity release has considerable appeal – the main alternative is to generate capital by moving to a smaller home. If you are in your 50s, it could make sense to take an interest-only mortgage for 10 years and then take out equity release: in this area, the older you are, the better the terms.

Summary

- Don’t push your overdraft beyond the agreed limit; make sure there is enough money in your account to meet direct debits and standing orders. If you see problems coming, speak to the bank first.

- Think how you want to set up bank accounts.Look at a feeder account to get better rates of interest. Do you want a joint account – if so,who can sign it?

- Make sure you have a cushion of six months’ income, available at a few days’ notice, to deal with the unexpected. Go after interest rates which beat inflation after allowing for tax: check with the internet.

- Use credit cards to borrow through balance transfers – but you must be precise on timing and use other cards for purchases. If you like certainty, think about a bank loan, but certainty means a lack of flexibility.

- If your house has risen in value, and you are over 60, think about equity release: lifetime mortgage or reversion. Under a lifetime mortgage, you don’t have to pay out any interest – it rolls up, so if you live another 20 years or more the debt will show a big increase. Talk to the family before you decide.