Maturing bonds can spell sudden rate pain

Savings bonds set up in the days of higher interest rates are now finished. Alessia Horwich and Julian Knight suggest what to do with the cash

Bank of England interest rates are down at just 0.5 per cent and, according to some experts, they are unlikely to rise for quite some time. While this is good news for borrowers, low interest rates provide savers with meagre fare.

All savers are feeling the pinch, but particularly those who got a much better rate of return with fixed-rate savings bond before the credit crunch. Tens of thousands of these bondholders who snapped up returns of up to 7 per cent or more pre-credit crunch are now in for a shock as their deals come to an end and their accounts revert to interest rates at a fraction of a percentage.

Unhelpfully, the procedure followed when a fixed-rate savings account matures depends entirely on the bank or building society holding your savings. “It’s a bit of a minefield when your fixed-rate bond matures,” says David Black, the head of banking at financial information service Defaqto. “Some banks will contact you and offer you new options for your cash, but others don’t and you may find you get dumped in a default account that pays a pitiful rate of interest.”

This is the case for the majority of bonds which, once they mature, will be moved into an easy or instant access savings account paying a low rate of interest. Customers who took out a five-year bond with Capital One in 2004 will see their rate nosedive by 5.1 per cent; on a £15,000 deposit they lose £765 in interest per year. Similarly, savers who invested in a FirstSave one-year bond last year will lose more than 6 per cent on maturity which equates to a loss of £953 interest a year on a £15,000 deposit. Banks have no obligation to inform you when your account reaches maturity. Rates may be lower now, but staying on top of your investment and finding a better deal will prevent your savings haemorrhaging interest while they languish in a poor paying account.

To the advantage of savers, banks are desperate to keep hold of cash, as they rely more on their savers to fund any lending. This means many will be trying to entice you to leave your savings with them and many are offering special retention rates on new bonds solely for existing customers. Where these deals offer the convenience of not having to move your money between banks, exclusive deals are not always a good idea.

“Although some products offer pretty attractive rates after maturity, they are not always reflective of the best deals available,” says Kevin Mountford, the head of banking at moneysupermarket.com. “It’s vital consumers shop around to ensure they are making the most they can from their savings.” The fixed-rate bond market is currently competitive with plenty of deals well above base rate. Bank of Cyprus is paying 4.05 per cent on a 15-month bond with a minimum deposit of £1. The AA has a two-year fixed-rate internet account paying 4.35 per cent on deposits from £500 and, if you can commit for longer, Yorkshire has a five-year fixed-rate account at 5.30 per cent for deposits above £100. Within a few weeks, there could be even better rates on the market. Even if your bond does revert to a low rate, it may still be worth holding your cash in the low-paying account for a while to see what else is on offer.

Other bonds require you to decide, at the time you take it out, what will happen to it on maturity, giving you choice and flexibility. Indian bank ICICI can pay your matured bond back into the obligatory HiSave account you open in order to deposit money in the bond. Or you can opt for the auto-renewal feature which will re-invest your money into the same term bond at the going rate at that time unless you opt out. ICICI currently has a competitive, three-year bond paying 4.70 per cent on deposits of £1,000 or more.

Similarly, Yorkshire Building Society offers a rolling one-year bond as one of its child investment products. This account gives you a one-month window on maturity to withdraw any or all of your cash without loss of interest, and then any funds remaining will be put into a new one-year bond. This will prevent you from suffering from rock-bottom returns, but it is the concept rather than the rate, at a low 2.00 per cent, that is interesting. Although a rolling bond is almost a built-in insurance policy, if you are fairly sure you can tie up your cash for longer than one year, it’s much better to go for a longer fixed-rate period as the rates will be much higher.

“The short-term bonds are better than variable rates,” says Rachel Thrussel, a savings expert at financial information service moneyfacts.co.uk, “but compared to long term rates, they are nowhere near as good. Providers currently want your money for longer and are willing to pay for it.