Wealth Check: House proud, but the home loan needs paying too
The owner of a Victorian villa wants a new bathroom. Must her savings go down the plughole? asks Harriet Meyer
Sunday 31 August 2008
Choosing the best means of financing £11,000 of building work is proving problematic for Sarah Barnes, 37, from Ware, Hertfordshire.
"Should I be remortgaging or using my savings to pay for this?" asks Sarah, a public relations consultant earning £35,000 a year. "I want to make sure I use my money in the best way."
The work includes putting in a new bathroom suite at her Victorian two-bed house, bought for £173,000 three years ago and valued at around £230,000 earlier this year – although that was before the property slump really took its toll. In fact, the latest figures released by the mortgage lenders Nationwide and Halifax show a drop of around 10 per cent on average in the UK housing market in the past year alone.
Sarah pays £470 a month for a 25-year £111,000 part interest-only and part repayment mortgage, with interest set at 4.99 per cent for two years. The deal is with Alliance & Leicester and lasts until October 2009.
To pay off the interest-only element of her mortgage, she has taken out two endowment policies. She pays £72 a month into a 25-year with-profits endowment with Norwich Union, set to mature in 15 years. However, she has received a warning letter saying that it is unlikely to reach its target of £44,600. She also pays £20 a month into a with-profits endowment with Standard Life. This one is on track to meet its maturity target of £8,900 at around the same time. In addition, she has 205 shares in Standard Life.
For short-term savings, Sarah has £11,850 in an online savings account with First Direct, earning 4.9 per cent. In focusing on saving for home improvements, she has put retirement planning on the back burner. She is not currently contributing to a pension, although she has two policies in place. These are both previous employers' money purchase pension schemes. The first plan, with Standard Life, has four years of contributions and a current value of £16,180.
As for the second, Sarah paid 3 per cent of her salary into this for just five months last year. "I have no paperwork on this, and my employer didn't contribute," she says. "My current employer doesn't have a pension scheme."
In the current murky economic climate – with unemployment widely predicted to rise over the next year – it is understandable that Sarah finds it hard to decide whether to borrow or dig into her savings to fund home improvements.
Our panel of independent financial advisers (IFAs) agree that Sarah would be wise to use some of her savings to finance the building work, rather than look to remortgage. But it is crucial that with current economic uncertainty she replenishes any savings she uses to fund the home improvement projects as quickly as possible.
Kelvin Lillywhite from IFA Albany Financial points out that if she takes out a loan or remortgages, any interest paid is likely to be far greater than that earned on her savings.
"However," adds Stuart Bourne, from IFA Buckles Investment Services, "it is a concern that, by using all her savings, she will be putting herself under unnecessary financial pressure."
As a solution, he suggests a short-term personal loan to fund part of the work. "The rate may be higher than spreading it over the term of her mortgage, but by paying off the debt quicker she may save a lot in interest."
At the same time, Sarah must bear in mind that borrowing rates and additional costs have soared since the start of the credit crunch, and she needs to prepare for a hike in her mortgage repayments when her fixed-rate deal ends next year. Switching to a repayment mortgage at some point is important, to ensure the capital debt is paid off at the end of the term. At the very least she should overpay on her mortgage to cover any shortfall from the endowment policy.
Holding individual shares is a high-risk investment strategy. Sarah should consider selling her stock in Standard Life and using it to kick-start an individual savings account (ISA).
Turning to the endowment policies, there are several options here. She could surrender them to the insurer that issued them or offer them for sale on the open market, which may bring a higher return, but she should seek financial advice before doing this.
"Bonus rates on with-profits funds have fallen significantly recently, and part of the premium goes towards life cover, which isn't essential for Sarah [as she has no dependants]," says James Norton from IFA Evolve Financial Planning.
Mr Lillywhite notes, however, that charges on these plans are higher in the early years; they tend to offer bigger returns, as well as terminal bonuses, later.
It is easy to think of pensions as the only planning tool for retirement. But the goal is simply to have enough money, whether that is in an ISA, pension, or investment portfolio stress the advisers.
Ideally, Sarah should split spare funds between a range of investments. However, if her salary rises and she becomes a higher-rate taxpayer, she will find pensions particularly beneficial.
"These offer excellent tax planning opportunities if you can receive higher-rate tax relief on your contributions, but pay only basic rate on your retirement income," says Mr Norton. "And you can take up to 25 per cent of your fund as a tax-free lump sum at retirement."
Sarah should ask for details of her previous employers' schemes and seek advice on the funds to see if they are suitable for her.
If her company employs more than five people, it is legally required to offer a stakeholder scheme or a personal pension.
"Her employer may be willing to pay into a personal pension of her choice on her behalf if she looks to reduce her salary," says Mr Bourne. "This is called 'salary sacrifice', and she benefits from not paying national insurance or tax on this money."
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