Making big financial decisions is tough at the best of times but when, like now the sand is shifting under your feet, the challenge becomes even greater. This week the Bank of England raised interest rates again, adding ever higher borrowing costs to the worry caused by higher food and energy bills.
These financial pressures can make it difficult to see beyond the end of the month, let alone plan for years into the future. So whether you are thinking of buying a house or wondering what to do about your pension, we ask experts how to make the best choices.
Is now a good time to buy a house?
Analysts agree that house prices are likely to fall in 2023 but there is no consensus on the magnitude of the decline, with the gloomiest forecasters suggesting a peak-to-trough drop of more than 25% once inflation is taken into account.
This week figures showed that house prices fell for the fifth month in a row in January, pushing the average cost of a home 3.2% below the peak seen last August. The cost of a home dropped by 0.6% in the first month of the year compared with December 2022, according to Nationwide’s monthly survey.
Demand for mortgages has collapsed to its lowest level since the 2020 Covid lockdown, with the number of home loan approvals falling for the fourth month in a row in December, according to Bank of England figures. So is now a terrible time to buy a property?
Dr Stian Reimers, a psychologist specialising in financial decision-making, says: “You need to consider the alternatives you have, right now. For example, [if you don’t buy a property] does that mean continuing to rent? Or living with your parents and saving up for longer? Compare the options you’ve got available at the point when you’re making your decision, not with what might happen in the future or what happened in the past.”
There are some unavoidable “what ifs”, though. For example, if interest rates continue to rise, that will obviously add to the affordability pressures facing many people by limiting how much they can borrow. Timescales are important, too. Most people buy a home for the long term but if there is a strong chance you will need to live in a bigger property or a different area in a few years’ time, you may find yourself selling at a loss if prices do fall.
Should I fix my mortgage or go for a variable rate?
On Thursday the Bank of England increased the cost of borrowing by 0.5 percentage points to 4%, leaving borrowers with the dilemma of whether to opt for a fixed rate mortgage deal or a “tracker”, which is a variable rate loan pegged to the base rate. At the moment the typical deal on a two- and five-year fixed-rate mortgage is 5.44% and 5.2% respectively, but 4.39% for a two-year tracker, according to the data provider Moneyfacts. As a result trackers are enjoying a surge in popularity, not only because of the lower headline cost but – with investors anticipating that interest rates will peak at 4.5% this summer and start to fall by the end of the year – because it will enable them to benefit from future base rate cuts.
“The decision about whether to fix – and, if so, how long for – will tend to come down to a balance between paying the lowest possible level right now and having certainty over the future,” says Sarah Coles, a senior personal finance analyst at Hargreaves Lansdown. “The right answer will depend on your situation and how much risk you’re prepared to accept when it comes to keeping a roof over your head.”
I need to improve my cashflow. Should I cut my pension contributions?
Last summer the TUC warned that growing numbers of workers were cutting their workplace pension contributions or opting out of schemes altogether because they could not afford the payments.
Cutting pensions contributions may take the pressure off in the short-term but you could lose out significantly in the long run, says Kirsty Stone, a chartered financial planner at The Private Office. “If you stop your pension contributions, it may stop your employer paying into the pension. So it’s not just your money that you’re not receiving any more, it’s quite often the employer’s contribution as well.” You would also miss out on tax relief on money going into the pension, as well as the opportunity to buy into investments while markets are low.
“A period of a few years of not contributing to a pension doesn’t sound like much,” Stone says. “But you get a compound growth effect on the savings, so if you put £1,000 in, and then that grows by 10% one year, and then that amount grows by another 10% the following year, you get that hugely valuable snowball effect.”
What’s more, breaking a good habit is a dangerous step. “The discipline of saving into a pension is much easier than the discipline of saving into an Isa, for example, since it’s done through your employer,” Stone says. “But once you stop it, at what point do you start that again?”
One option is to take them down to the minimum point at which your employer will continue to contribute. If you do make the decision to stop paying in entirely, why not fix a date in the future – perhaps in six months – when you will commit to start paying in again.
Should I take money out of my pension fund?
If you are struggling with rising costs, it may be tempting – if you are over 55 – to dip into your pension savings. After George Osborne’s changes to pension rules implemented in 2015, lots of over-55s have been able to withdraw money from their pensions, 25% of which can usually be taken tax-free. There are even firms who offer to help you to do so. But just because it’s possible doesn’t make it the right decision.
It could result in a large tax bill, and have an impact on your eligibility for certain benefits, as well as reducing the amount of money you have to live on in retirement. “Don’t make rash decisions on long-term goals based on what is a very short time,” Stone says. “Someone who has been saving into a pension since they were 20 or 25, for example, might live to 100. When they retire, the hope is that their pension will be invested for another 30 or 40 years, because it should be invested for ever. You shouldn’t spend it – you will need it until the end.”
Stone says individuals also need to consider the tax implications. “Above your tax-free cash entitlements and personal allowance, people will be paying their marginal rate of income tax, 20%, 40% or 45%, on withdrawals. Those are large numbers to lose in tax. If people decide to draw more income than they need in this year, they could be paying too much tax and cementing, in the majority of cases, at least a 20% tax bill, which really means a 20% loss in the value of the pension as it’s paid out in tax and cannot be recovered.”
How do I cope with an unexpected expense?
Your boiler needs fixing, your car’s clutch gives out, you need to repair the guttering. Working out how to fund an unexpected expense is not always straightforward. Indeed, according to a recent Money and Pensions Service survey, 9 million people across the UK have no savings, while another 5 million have less than £100.
Some people may have family or friends who are able to bail them out with a interest-free loan but if you don’t have this option, make sure you borrow at the lowest possible rate and pay it back as soon as possible.
Alex Hodges, a money expert at MoneySuperMarket, says it is important to compare the cost of different products, such as a loan or credit card. “The rate you’re offered will depend on your circumstances, so check that your credit report is up to date and use a pre-application eligibility tool to see what options could be available.”
Beware when shopping around, though, as multiple applications may damage your credit score. “Using an eligibility tool, like the one on MoneySuperMarket, means you can find out which products you’re most likely to be approved for before you make a full application,” Hodges says. “Once you apply, there will be a hard search on your credit report. Your credit score may temporarily reduce after this search but it should return to its previous level relatively quickly.”
Should I focus on paying off my debts or building up savings?
It is worth having a “sinking fund” for big, planned purchases over the next five years, Coles says. “That way, you benefit from the interest on savings rather than paying interest on debts.”
But what if you have credit card or loan debts – is it better to pay them off before you start saving? “It depends on the debts,” Coles says. “If they are expensive, short-term debts, they should be your first priority but if it’s something like the mortgage, you should pay this alongside building your savings pot.”
However, she adds that if you are constantly paying off short-term debts, that doesn’t mean you shouldn’t also save. “Ideally, you should draw a line in the sand, pay off your [expensive] debts, and then start saving. But, failing that, you may want to start building up some savings alongside debt repayment.”
Can I just do nothing?
“It’s often a lot easier, and it feels a lot safer, to do nothing. To say: ‘I’m not going to engage with this because I may get it wrong,’” Reimers says. “But obviously that’s a decision in itself.”
Even something such as moving cash into a better-paying savings account can help improve matters. Recent research from Hargreaves Lansdown indicated that almost £270bn is languishing in accounts paying no interest.
Just over a year ago, when the base rate was still at 0.10%, the best easy access account on the market was paying about 0.71% – today Shawbrook is offering 2.92%, more than four times as much.
The trouble is, of course, that the UK’s inflation rate is now 10.5%, so no matter where you keep your cash, it will lose value once this is taken into consideration.
“Cash is never designed to keep pace with the cost of living. It’s there to give you certainty, and confidence that you can cover your bills and any ad hoc costs for a period of time,” Stone says. “So getting it working hard is really, really important. Making sure your cash is in the best-paying accounts is an easy win.”
Fixed-term savings, where you lock your money away for a set time, tend to pay better rates. At the moment, SmartSave has the highest-paying one-year fixed-rate bond at 4.16%. For those prepared to lock their money away for two years, Atom Bank is offering 4.45%.
Savers who want to keep some access to their money can get 3.6% by opting for a notice account. The Hinckley & Rugby building society is offering that rate to savers prepared to give it 120 days (about four months) if they want to make a withdrawal.
“Some people are wary because with interest rates on the rise, there’s a chance rates will nudge up again and make your fixed rate look disappointing,” Coles says. “However, you need to be careful you don’t leave your cash languishing in a miserable easy access account.”
Reimers says: “It’s not a very attractive choice to make: ‘Do I want to lose more money or lose less money?’ If the choice was: ‘Here’s an opportunity to make some money,’ people might be more actively inclined to actually start engaging with it and making some decisions. But when it comes to minimising losses, people are not happy making those decisions – though it’s just as important.”