Should I pay off part of my home loan? ... Should I hold shares in a PEP? ... Are my savings safe? Each week we answer your letters on everyday financial concerns and explain how to make more informed choices
Sunday 16 June 1996
A common question - but there is no easy answer. Assume your mortgage rate is 7 per cent. Mortgage interest tax relief (Miras) will bring down the effective rate on a loan of pounds 30,000 or less to 5.95 per cent (85 per cent of 7 per cent since Miras tax relief is at just 15 per cent now).
In simple money terms, investments that earn you more than this rate are worth while. If they earn you less, you may be better off reducing the loan.
With investments, it is the after-tax return figure that is important. It is still possible to earn 5.95 per cent gross from a taxable building society account. But if you are a basic or higher-rate taxpayer then, unless it is a Tessa account, you will face tax on this interest - so reducing the return.
Basic-rate taxpayers pay 20 per cent on the interest (and much other investment income) earned with most building societies. Dividing 5.95 per cent by 0.8 gives you the before-tax interest rate - 7.44 per cent - needed to cover the cost of the mortgage. Higher-rate taxpayers (at 40 per cent) divide the 5.95 per cent by 0.6 to get a break- even rate of 9.92 per cent.
Neither before-tax rate is readily available from normal building society savings accounts.
If you are a non-taxpayer or you are looking at tax-free investments, your break-even level will be the same as the mortgage rate - that is, much more attainable.
Other questions to ask yourself include the following:
q Do you have enough cash on deposit for emergencies?
If not, it makes sense to hang on to your money.
q Will you want to borrow again in the foreseeable future?
If so, it may also be better not to reduce your home loan. Mortgages are the cheapest form of borrowing available, but they are not normally as flexible as overdrafts. Often it will not be financially viable to increase them again by relatively small amounts.
Find out when a partial repayment of your mortgage actually has an effect on the interest you are charged. Odd as it may seem, there can be delays before you see a financial benefit. And make sure there are no early- redemption penalties for partly repaying the loan.
I am considering investing in a small British company. Should I hold the shares in a PEP? At what level of return do the costs of Pepping the shares outweigh the benefits of tax-free income and capital gains? GR, London
It depends on your own tax position. A large part of the returns from investing in shares in small companies tends to come through in the form of capital gains, rather than dividends.
Consider whether you are likely to pay capital gains tax. Most investors avoid this tax even outside a personal equity plan. The first pounds 6,300 of gains realised each year is free of capital gains tax. In addition, you can claim an allowance for inflation.
If you get to a stage where you are likely to hit the capital gains tax threshold, you can always consider Pepping your shares at that point. The dealing costs of selling them and buying them back through a PEP are likely to be less than paying PEP charges year after year from the start.
Then there is income tax. A basic-rate taxpayer saves 20 per cent tax - one-fifth of the dividends - in a PEP. Many personal equity plans make a charge of, say, 1 per cent a year. With VAT added, that works out at 1.175 per cent a year. Multiplying 1.175 per cent by five gives 5.875 per cent. If the annual dividends are below this level, a 1 per cent annual charge will not be covered by the income tax saving.
The break-even dividend level for 40 per cent taxpayers is half that for basic-rate taxpayers. In this example, it would be 2.94 per cent.
PEP charges can be percentage based or flat-rate. Also look for share- dealing charges that are higher than buying and selling shares outside a PEP. If the sums do not add up, avoid the personal equity plan.
If a building society collapses, savers get some protection. What security will there be when the Woolwich (or indeed another society) becomes a bank? BW, Loughborough
Banks and building societies are both covered by statutory schemes that give some protection to savers if a bank or society collapses. Building societies are covered by the Investor Protection Scheme, banks by the Deposit Protection Scheme.
Both protect 90 per cent of your savings up to pounds 20,000. If your savings are pounds 10,000, you would be guaranteed to get back pounds 9,000 in the event of a collapse. If you have pounds 20,000, you would be guaranteed pounds 18,000. But there is no protection for amounts above pounds 20,000.
The schemes protect each depositor, not each account. So if you have pounds 40,000 spread equally across two different accounts with the same bank or society, the maximum payout would still be only pounds 18,000. But two people with pounds 40,000 in one joint account would each get pounds 18,000.
Only the scheme covering banks has had to pay out in recent years, but in most cases this has followed the collapse of fairly small banks. It seems highly unlikely that your savings will be particularly at risk once the Woolwich becomes a bank.
Write to Steve Lodge, Personal Finance Editor, Readers' Lives, Independent on Sunday, One Canada Square, Canary Wharf, London E14 5DL, and include a telephone number. Do not enclose SAEs nor documents that you want returning. We cannot give personal replies and cannot guarantee to answer every letter in Readers' Lives. We accept no legal responsibility for advice.
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