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Should you lock away your savings in a seven-year bond?

Find out how future base rate changes could affect your savings

Should you lock away your savings in a seven-year bond?

The PCF bank raised the rate on its seven-year fixed-rate bond, so that long-term savings are looking increasingly attractive. But is it a good idea to put away your money for nearly a decade – especially when the Bank of England base rate seems to be on the move?

The bond now offers 2.75% AER, the highest rate for this term – but is it worth it?

Which? finds out what effect the base rate could have on future savings rates, and whether it’s worth locking in the highest rates now.

Should I get a seven-year fixed-rate bond?

Currently, if you have savings, the highest rates available are offered by fixed-rate bonds – and the longer you commit to saving your money, the higher the interest.

Seven years is the longest term bond, and therefore offers the highest rates.

The good thing about these accounts is that you’re guaranteed to get that level of interest, as it’s a fixed rate.

The downside is that if you have to withdraw some or all of the money before the seven years is up, you’ll be faced with a penalty and may loose some of the interest you’ve earned.

This can be problematic if you experience an unexpected expense and urgently need access to your savings.

You’ll also be unable to take advantage of any higher rates launched after you’ve started saving into the bond.

You should also consider that there are far fewer seven-year bonds on the market.

The table below shows the seven-year fixed-rate bonds offering the highest interest rates.

Account AER Minimum initial deposit
PCF Bank 7 Year Term Deposit 2.75% £1,000
Shawbrook Bank 7 Year Fixed Rate Bond 2.4% £5,000
United Bank UK 7 Year Fixed Term Deposit 1.95% £2,000

Source: Moneyfacts.co.uk

If you were to go for the PCF Bank Seven Year Term Deposit, you’d earn an estimated £192.50 in interest on a £1,000 over the course of seven years.

While the top two rates are higher than other fixed-rate accounts on the market, the highest rate five-year fixed-rate bond isn’t far behind – Charter Savings Bank’s 5 Year Fixed Rate Bond offers 2.68% – more than both the Shawbrook Bank and United Bank UK seven-year accounts – and means you can access your money two years earlier.

With this five-year bond you’d earn an estimated £141.38 interest on a deposit of £1,000.

It’s a difference of £51.12, or £25.56 for each of those two extra years. You have to weigh up whether you feel that kind of difference is worth it for your circumstances.

Find the right place for your savings with Which? Money Compare, where you can find hundreds of savings and Isa accounts.

What effect could further base rate increases have?

In August, the Bank of England increased the base rate by 0.25%, so it now stands at 0.75% – the highest level in almost a decade.

There is speculation that suggests the rate could be increased further in coming months.

Usually, base rate rises are passed on by banks to mortgage rates, loans and credit cards, as well as savings rates. But a month has gone by since the last base rate rise, and only a handful of banks and building societies have passed on the full 0.25% increase.

We recently wrote about NS&I – the government-backed savings provider – failing to pass on the base rate to savers as it only increased its savings rates by 0.05-0.15%. Other providers have been similarly lacking.

If the base rate increases again, lenders will be under increasing pressure to up their rates – so the best deals might be yet to come.

To gauge the potential changes, we could compare the current best-rate one-year fixed-term bond with the PCF Bank Seven Year Term Deposit.

Currently, the My Community Bank 12 Months Fixed Term Deposits account offers 2.1% AER. The difference in interest between this and the seven-year bond is 0.65%.

If banks did pass on future base rate rises, it would take just three more increases of 0.25% to bring this one-year bond in line with the seven-year bond – who knows what kind of rates would be on offer for longer-term bonds at that time.

This, however, would involve the base rate rising to 1.5% – a level that hasn’t been seen since December 2008. Then, again, the base rate stood at 5.75% in July 2007, so it’s worth bearing in mind that we’re in a period of historically low rates.

The graph below shows how the base rate has changed since 2007.

Don’t forget about inflation

The rate of inflation is reported each month and measures how prices of an imaginary shopping basket of common goods and services have changed compared to the same period the previous year.

The Bank of England’s target is to keep inflation at 2% – higher inflation would mean that prices increase faster than people’s wages, so it will cost them more to buy the the same products than the year before.

One of the ways to force inflation in a certain direction is to change the base rate. The recent decision to increase it is likely to be the result of inflation remaining well above 2% since early 2017.

When the base rate rises, pushing up savings interest, people are encouraged to save rather than spend, resulting in a dip in demand for products and services, along with prices.

If the base rate continues to creep upwards, then inflation should fall. All this means that, as long as your chosen savings account beats the rate of inflation, your money will still grow – even if you are locked into a long-term deal.

As for the seven-year bonds currently on the market, they comfortably beat the current rate of inflation – and will continue to do so if the base rate jumps.

But, seven years is a long time. The graph below shows how inflation has fluctuated since 2013.

In just November last year, inflation rose to 3.1%. If this happens again over a long period of time, the savings you’ve locked in a fixed-rate bond will end up losing money in real terms at the current rates. So it’s worth thinking carefully before committing your money to a seven-year term.

Which? Limited is an Introducer Appointed Representative of Which? Financial Services Limited, which is authorised and regulated by the Financial Conduct Authority (FRN 527029). Which? Mortgage Advisers and Which? Money Compare are trading names of Which? Financial Services Limited.

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