If you are a first-time buyer, rising interest rates may feel like a dark cloud looming ominously over your home purchase.
But if that’s the case, then savings rates are the silver lining.
A combination of consecutive Bank of England base rate rises and competition from challenger banks and building societies mean average savings rates are on the rise.
If you have enough money to put away for your deposit each month, then the interest you will be earning now will be better than it has been in years.
But which type of savings account should you use to build your deposit?
The answer really lies in several factors – the timescale over which you are saving, how frequently you plan to put money away and even your age.
We’ll run through five options you can choose for saving money and explain who they would be most suitable for.
1. Current accounts
Current accounts have the benefit of allowing you unlimited access to your money. Whilst their purpose is not for saving, those with plenty of self-control may find them a convenient way to build a deposit and keep it close to hand should you need it.
You could also use your current account in tandem with another savings product (as described further on) to keep your savings compartmentalised.
Pros: Money is close to hand and easy to access
Cons: You won’t earn interest and you may accidentally spend some of the savings. It may not be easy to keep track of how much you have saved.
Who are current accounts most suited to? Anyone who’s about to make their house purchase and has received the money as a lump sum – for example an inheritance.
2. Lifetime ISAs
If you are under the age of 40 then Lifetime ISAs (LISAs) are an ideal way to save for your house deposit. They allow would-be homeowners to save for their first home but they can also be used for pension saving.
LISAs have the advantage of a 25% government bonus every year on whatever you have saved. The maximum annual deposit is £4,000 so that’s up to £1,000 you could receive in addition to the interest.
Alice Haine, personal finance analyst at Bestinvest, the DIY investment platform and coaching service, described the bonus as a ‘turbocharge’ for your savings.
She added: “As well as the £1,000 annual cash bonus, LISAs come with the same tax benefits as other ISAs, with any income or capital growth shielded from income tax, capital gains tax (CGT) and dividend tax.
“With the 25% cash bonus paid every month until the accountholder hits 50, the maximum bonus for someone who opened an account at 18 and maxed it out until they hit 50 is a very generous £33,000.”
Pros: The potential receive up to £1k per year is a real coup for savers with an ISA. Plus, if you are buying with another person you can open separate ISAs and combine the funds from both parties to enhance your purchase power.
Cons: There are some strict and complex rules attached to ISAs as well as the age restrictions, the account must be funded for 12 months before you buy your first home. Haine said: “There is no point transferring funds into a LISA to make a quick purchase on a home as this won’t fulfill the requirement.”
For first-time buyers the money must be used for a home purchase and if it’s not used for this it must remain in the ISA until the accountholder turns 60 when it can be used for retirement. Should you withdraw the money before this time you will lose the 25% bonus.
The value of the property you can buy is capped at £450,000, you must buy the property with a mortgage at least 12 months after making your first LISA contribution.
If you are 40 or over, you are not eligible which excludes a rising number of first-time buyers.
Who are LISAs most suited to? Anyone between 18 and 39 who is saving for a home and expects their property to be less than £450k in value. You’ll need to be saving for at least a year so LISAs won’t work for anyone planning to buy in the next 12 months.
3. Easy access savings accounts
Easy access savings accounts – as the name suggests – offer savers a safe place to put their money but also allow penalty-free withdrawals.
Most easy access accounts have variable rates which mean they can change at any time.
There are plenty of easy access accounts on the market and experts advise you shop around to find the best rates and don’t automatically sign up to the account being offered by your bank. Indeed, most high street banks tend to offer the lowest rates with the smaller brands having the competitive edge when it comes to returns.
Pros: The plus side of this is greater flexibility. You can generally access your savings whenever you wish, which is handy if you meet your savings goals and find your dream home sooner than expected.
Cons: The interest rates on these accounts are generally lower than other types of savings products and they could go up or down at any time. If you choose an easy access account then you should certainly shop around and consider the lesser-known providers – challenger banks and building societies – which often have the most appealing rates.
Before opening an easy access account check to make sure there are no restrictions on withdrawals as some may reduce the interest if there is too much activity.
Who are easy access accounts most suited to? If you think you may need to access some of your savings whilst building your deposit then easy access are the best option.
You could also have an easy access account as well as another, higher paying and less flexible, savings plan running in tandem and divide your deposits between them.
This plan is ideal for anyone who thinks they may need the money for the easy access account for an emergency or unexpected payment.
4. Fixed rate, notice or regular savings accounts
These accounts all pay higher interest than easy access accounts but they come with varying degrees of restrictions.
Notice accounts
If you want to find slightly better rates than easy access tend to pay, but still want some flexibility, notice accounts are a good alternative.
Pros: Savings rates usually outshine those of easy access.
Cons: As the name suggests, you will need to give notice if you wish to withdraw your money.
Regular saver
Meanwhile, if you would like an account designed to get you into the savings habit, a regular savings account could be ideal. These allow you to put away a set amount each month and earn a decent rate of interest.
Pros: These offer strong rates whilst encouraging good savings habits.
Cons: The advertised rate may look much higher than other types of savings account but the interest is drip fed as you put money away so is a little more complex to calculate. There may also be penalties for taking out money.
Fixed rate accounts/bonds
Fixed rate accounts – often called fixed rate bonds – meanwhile, not only have the best interest rates but this rate of return will not change for the duration of the account. If you put your money into a fixed rate account paying 5% for two years that won’t change, no matter what happens to the Bank of England base rate.
Pros: They tend to offer the best rates on the market
Cons: The downside is you cannot access your money in this time.
5. ISAs – cash and stocks and shares
You can save up to £20,000 a year in an ISA, which is a tax-free savings plan. Cash ISAs are available as easy access, fixed rate, notice accounts – in all the forms we’ve mentioned already. The only difference is they are tax free – imagine them as being covered in a wrapper which protects the interest earned from tax.
If you are basic or higher rate tax payer you will not pay tax on up to £1,000 or £500 of interest, respectively. So it’s worth considering this before opting for an ISA.
You can also invest in stocks and shares ISAs which earn returns based on the value of companies in the stock markets.
Haine said this option is best for those with a time horizon of five years or more since, over the short term, markets tend to be volatile. Over a longer term they have the potential to produce inflation-beating returns.
Haine said: “This is never guaranteed of course, which is why regularly drip-feeding money in is the best option as this takes advantage of pound-cost averaging.
“With this strategy, rather than buying a lump sum at a single price point – such as during a supposed dip – investors can buy smaller amounts at regular intervals no matter what the price is at the time.
“This cushions some of the effects of volatility in the short- and medium-term and by staying invested for the long term investors can further moderate risk and increase the chances of decent real returns.”
Pros: Both cash and stocks and shares ISAs allow you to save up to £20,000 a year without paying any tax. With stocks and shares ISAs, the potential to earn inflation-beating returns – currently not available in cash savings – is available over the longer-term.
Cons: There are risks investing in the stock markets and the value of your investment can fall as well as rise.
Who are ISAs most suited to: Cash ISAs are ideal for people who want to access their money for short term goals, advises Haine. Stocks and shares ISAs, meanwhile, are better for someone with a longer term goal who wants to build greater returns.
Haines’ tip for younger savers keen to build up a deposit to buy their first home is a combination of a LISA and a Stocks and Shares ISA. “That way £4,000 a year can be saved into LISA, with a £1,000 bonus added to the pot per year, and up to £16,000 saved into a Stocks & Shares ISA – using up the £20,000 tax-free ISA allowance in full,” she said.
If you are considering investing in the market, we recommend speaking to an independent financial adviser first.
