The UK State Pension

by Magical Penny on August 23, 2010

What do you think of when you hear the word ‘pension’?

The Oxford Dictionary describes a pension as:

“…a regular payment made by the state to people of or above the official retirement age and to some widows and disabled people”

In the UK, this is referring to ‘state’ pension. In the US it’s called “social security”. In any case, this ‘regular payment’ is very small amount you are paid when you are old is just about enough to eat and keep the lights on, but not much above that. However it’s an important piece of the pension puzzle so you should at least know the basics.

Does Everyone Get a Pension?

As with most things tax-related, it depends.

The state pension is funded by national insurance contributions, the ‘tax’ you pay the state for all social services if you are earning £95 or more a week (in 2009/10). In the UK this includes your pension and the national health service. The amount of your pension is therefore linked to the number of years you have been paying National insurance contributions.

Note: if you’re a small business earning a profit of less than £5075 you don’t ‘have’ to pay national insurance contributions but it’s worth considering doing so if you are short of years to fully qualify for a state pension- see below).

Contributions

If you haven’t retired yet you are nearer to qualifying for a state pension than anyone else has ever been at your age. The old rules said you had to make contributions for 44 of the 49 years between the ages of 16-65 to receive a full state pension.

This has now been cut significantly after The UK Pensions Act 2007 which reduced the number of qualifying years needed for a full basic State Pension to 30 for people who reach State Pension age on or after 6 April 2010.

Even better if you fall short of the 30 years of contributions you can ‘buy’ extra years to make sure you qualify for the full monthly payment. You can also still receive a full pension even if you’re out of work for some of those years -as part of any unemployment or disability benefit your national insurance contributions are paid, so from a state pension perspective it’s like you were never unemployed.

You can also have your National Insurance contributions paid if you’re a full time carer so have other special circumstances so if you are not paying National insurance for any reason make sure you’re not missing out by visiting the UK government’s website: direct.gov.uk.

If you pay less than 30 years worth of National insurance you still get a partial pension depending on the number of years but there is a risk you may qualify for nothing at all if you pay less than 10 years of contributions.

Is a Basic Pension enough?

Knowing about Magical Penny and my enthusiasm for getting your long-term finances sorted, a friend joked to me that a state pension didn’t seem that bad. At least I hope he was joking -if you have minimal needs then perhaps he’s right. It is possible live on the state pension -millions do, but even the government says the state pension has its limitations on the direct.gov.uk website:

“It can give you a reliable foundation for your income in retirement, although it might not be enough to support the lifestyle you want.”

In 2010-11, a single person can get a maximum of £97.65 a week basic State Pension (£152.40 for a married couple).  Seem a bit small? Even the government recognises this -if this is your only income you can have your pension topped up with a ‘pension credit’ to a total of £130.00 a week (198.45 for couples).

Conclusions

The Oxford Dictionary might have been right about its definition of a pension as a ‘regular payment’ but its not as simple as that. The basic state pension is really helpful at almost guaranteeing you an income when you reach your advancing years yet, as this article has shown, tax rules are always changing and can be difficult to follow.

One thing is for sure though: Relying on a state pension will limit your lifestyle options.

Thankfully it’s never been easier to become empowered about saving for the long-term and Magical Penny will show you how in future articles in this Pension series.

Other Reading

Best Of Money Carnival #64

Carnival of Personal Finance #271 – The Secret to Successful Budgeting eBook Edition | Provident Planning

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Lessons from Toy Story 3 -Grow your pennies to infinity and beyond

by Magical Penny on August 18, 2010

I’ve just returned from the cinema where I went with my sister to see Toy Story 3. It may be about talking toys but it was filled with some wonderful script writing and it’s a thoroughly enjoyable film.

Amidst the humour and tension there are some powerful life lessons so here’s a few I picked up and how they relate to growing your pennies!

This post contains spoilers so only read if know or want to know the plot

Mistakes happen

Buzz and other toys should have been safely put away into the attic when Andy heads off the college. Instead, his Mum takes the toys out to the curb. Like the other Toy Story films the plot is driven by an accidental mistake happening and the attempt to put things right.

Life, for both the toys and ourselves, rarely goes smoothly.

Mistakes do happen. Yet the toys never give up in their mission to get home. Their determination is admirable and is a lesson for us all.

You will make mistakes (with your money and otherwise), the hard, but most important part, is that you pick yourself up and get your focus back.

The power of a well-executed plan

Escaping from being taken away with the trash, the toys take refuge in a box destined for day-care, but after reaching their destination, find that the centre is not what it seems.

They are trapped in a room with only a small window high above them.

It’s impossible for a toy to reach.

But, moments later, Buzz is flying through the air -or rather, falling with style – catapulted by a series of aerial stunts, to the promised land of the open window. It is a true testament to the power of a well-executed plan.

Just like looking at an impossibly high window, we face our own challenges in life: thinking about all the different things we need to buy in the coming years can be daunting. Cars, houses, weddings, retirement…it may seem unachievable sometimes. But if, like the toys, you develop a game plan, then with a bit of luck and creativity, you’ll get there.

Spend on the things that matter to you, not anyone else

Ken is teased for his extensive clothing collection. From an outside perspective it seems ridiculous to have so many outfits to wear but Ken is delighted when Barbie gives him the opportunity to wear them.

Many of us have the equivalent of Ken’s wardrobe. We spend our money on things that our friends or family don’t understand: perhaps piles of books, shiny electronics, or flash cars?

People often think personal finance is about cutting back, being sensible with your money.

It’s not.

It’s more about being conscious with your spending.  Certainly you should make sure you’re saving for your goals in the short and long term, but you should also not feel bad spending money in the present on the things that matter.

But also remember, Ken might have enjoyed his ‘stuff’ but he had even more fun when he had someone to share the experience with. As Suze Orman says: “People, then Money, Then Things.”

Mix it up a bit -you might just like it

In the midst of the adventure and daring escape, Buzz is reset to factory settings and reboots into a Spanish version of himself, much to Jessie’s delight.
Buzz’s Spanish transformation offers a much needed comedic element easing the tension that has built up, and Jessie finds a whole new side to Buzz, changing the way she feels about it forever!

Similarly in life, random events and meet ups happen all the time and can send your life down a whole new path. Being in control of your money makes it much easier to follow these opportunities. Certainly a budget helps you stay focused but it also allows you to ‘mix it up’ a bit which time and again can lead to a more fulfilling and fun life- and who doesn’t want that?

-To use a personal example, in recent weeks my budget has allowed me to head off to Ireland for an evening, and I’m heading to NYC in September!

It’s never too late to redeem yourself

Towards the end of the film, Ken sees the error of his ways and switches allegiances to Woody and the gang. It’s a risky move but Toy Story 3 teaches us that it’s never too late to be redeemed from poor judgement in the past. Woody even gives the evil, strawberry smelling, teddy bear an opportunity for redemption.

Likewise it’s never too late to redeem yourself from poor money habits or judgements you have made in the past. The sooner you get started on the right path to growing your pennies, the more time you have for your savings to grow.

Life goes by so fast

I remember when Andy was young, playing with Woody and Buzz in the first Toy Story film. By Toy Story 3,  Andy has grown up and is moving to college. Life goes by so fast!

  • You may think you’ve got ages until retirement or before you get started on the property ladder but it will come around so so fast.
  • You may think you’ll begin saving when you’re earning more money.
  • You may think you’ll start learning about investing when you have a little more time.

But, like Andy, you’re growing up fast

Toys fear their owners growing up and not playing with them anymore. Thankfully we don’t have to fear the future. Follow through with a plan and we can embrace it.

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Final Salary Pensions

by Magical Penny on August 11, 2010

Pensions shouldn’t be the scary, confusing, or boring. But they are. And for good reason!

They are rarely flexible, have expensive fees, and worst of all, are seen by many as something you start in middle age.

As you’re reading Magical Penny I hope I’ve convinced you that you should be saving for the long term whatever your age but navigating the dizzying array of options out there can be difficult.

Today, I’m beginning to lift the lid on pensions with Part 1 of the Magical Penny Pension series, helping you find the best way to grow your pennies for retirement.

To begin we’ll be looking at the traditional final salary pension.

Final Salary Pensions

The traditional pension of the 20th century was that of a ‘final salary’ pension: Many professional jobs offered such a scheme where every month you and your employer would pay into a ‘pension fund’, an investment account that would grow over time. When you came to retirement, you would then receive a ‘pension’ equal to a proportion of your ‘final salary’ depending on the number of years you have worked at the company.

The great thing about final salary pensions is you can work out how much your pension will be each month.

For example if your company offers you a 40th of your final salary as a pension and you work for the company for 20 years ending on £40k a year, you will retire on half pay (your pension will be: (40000*0.025)*20 =£20k a year).

This type of pension is known as a “defined earnings” pension as you know how much your monthly income will be. You don’t have to know anything about investing but still finish with a comfortable retirement income for the rest of your life.

Another compelling reason to have one is how generous they can be. You do not have to save as much nor take on as much investment risk to secure a good income in retirement. If you wanted to guaratee a £20000 a year income without a final salary pension scheme you would need your pension pot to be hundreds of thousands of pounds.

As it is ‘defined earnings’ it’s the pension fund’s responsibility to pay you what you are promised. Compare this to if you were investing yourself into a pension ‘defined contributions’ -if your investments go down you are out of luck and money, but if a final salary pension fund loses value, the fund goes into debt in order to keep paying you!

Whilst final salary pension schemes have their merits they can also be troublesome:

If the investments in the pension fund do not grow as expected, the pension fund can end up with a deficit (debt). This can cause all sorts of problems and if you have not yet retired some schemes have been known to be ‘creative’ with their calculations on what they are able to pay you as a pension when you eventually do retire.

Also the rules differ on how the final salary is calculated so if you have such a pension make sure you understand it. Some schemes take an average of your salary during the last 5 years, whilst others look only at what you were earning in your last year.

Others still might take an average of what you earned for the past 10 years then divide that by the number of letters in your name, then multiply that by pi. You think I’m joking?

It is worth noting too that there have been been instances where ‘final salaries’ of employees have been cut just before retirement so their final pension is dramatically reduced.

There is therefore an element of luck involved and when we’re talking about the income you will be receiving for the rest of your life who wants that?!

Final salary pension schemes also tend to unflexible and non-transparent. You are likely to have little control over the investments in the fund. There may be instances where you feel uncomfortable not knowing where your money is going each month, particularly if the investments chosen are not deemed ethical by your standards.

Another thing to consider  are costly fees for administration and commissions.You wouldn’t notice them as they come out of the pension fund itself but your company’s investment returns calculations will have included them so the odds are you are getting a lower rate of return than if you had set something else up as your retirement savings vehicle.

Lastly final salary pension schemes can also act as ‘golden handcuffs’ -if you know you will give up a guarateed £20k for life you may be less inclined to leave the company before you retire, even if it would otherwise be the right thing to do for your career, your family, or yourself.

Conclusion:

Final salary pensions work well if you are with a company for many years. But the world is very different now than when such schemes were being introduced in the 20th century.  It is unlikely you will be at your current company for decades. Moving from job to job could result in numerous pension accounts scattered around different providers and final salary pensions are harder to calculate and understand so make retirement planning more difficult.

Final salary pension schemes tend to be quite generous but they are becoming increasingly rare. Companies do not want to take the financial risk of having to pay out the ‘defined earnings’ and adminstratively it is costly, particularly as people are less likely to be at their current job for a lifetime.

Despite their flaws, if your company does offer a final salary pension scheme it makes sense to join given how generous they tend to be. That said, as final salary pension schemes are not always straightforward nor do you have much control, it should not be your only retirement savings strategy.

Thankfully there are many other ways to save that are less complicated, and Magical Penny will detailing them in later posts in the series.

If you have a final salary pension scheme leave a comment if there’s anything you would like to share about it to help other readers!

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Foreigners Finances Podcast: Beginning Investing with Adam from Magical Penny

by Magical Penny on August 9, 2010

Perhaps it’s because talking about money is so taboo in ‘real life’ that I find the frank discussion and exchange of ideas so interesting and different. And a few months ago I came across something completely different:  a young American talking about money in Japan!


Ever since discovering it I’ve a big fan of Foreigner’s Finances, a site founded by Austin, an American personal finance blogger currently living and teaching English in Japan.

After reading his blog for a few months I jumped at the invitation to speak with Austin about investing as 20-somethings and the differences between money in the U.S. and the UK.

Click here to listen to the interview!

When you’re had a listen we’d love for you to leave a comment if you enjoyed it and be sure to subscribe to Austin’s financial related podcast’s RSS feed or download and subscribe on iTunes to get every future episode delivered to you.

Other Reading

The Carnival of Personal Finance

Best of Money Carnival

Be sure to follow Magical Penny on Twitter and ‘like’ it on Facebook too!

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Do You Find Pensions Confusing?

by Magical Penny on August 4, 2010

Meeting new people is fun and naturally when people ask what I do, I often start talking about Magical Penny.

Because of this revelation earlier on in the week, the conversation in the pub the other day turned to pensions (Yes I know how cool we are!).

Some of my friends have no pensions (the horror!), but two friends mentioned they had final salary pension schemes, whilst others had stakeholder pensions, or private pensions.

Confused?

Thought so.

Pensions are one the most confusing financial product out there!

According to a recent study by the University of Bristol and Confused.com, pensions are the most confusing product, with 83.9% of people finding them confusing.

In fact 33.8% of people said they were ‘very’ or ‘totally’ confused by pensions. That’s over a 3rd of the 6000 respondents in the survey!

I enjoy learning about financial products and even I struggle to get my head around all the different options sometimes.

Confusion on pensions is not surprising though.

There is so much choice of pension products and within each pension product there are thousands of funds and investments to choose from. Most people are either crippled by too much choice, don’t think they need to save just yet or are saving in a pension but are likely to be getting a poor deal.

Introducing the Magical Penny Pension Series

Magical Penny‘s primary aim is to help you understand how you can grow your pennies and get started on saving for your future.

Starting only a few years earlier than you might have otherwise can mean the difference of tens of thousands of pounds over the course of your lifetime so it’s important to learn about the differences between different pension products and if you even need to have a pension at all (hint: it’s not always the best way to save your your future!).

Before the series starts I would love to hear your questions or suggestions on what pension information you are most interested in. Leave a comment on this post or send me an email at adam AT magicalpenny.com.

Have a great week and keep saving. 🙂

Source: Confused Nation study:

The study revealed that:

  • 71.9% of people suffer from confusion over how to make money and use it wisely;
  • Pensions are the most confusing product, with 83.9% of people finding them confusing;
  • 33.8% of people said they were ‘very’ or ‘totally’ confused by pensions;
  • 79.1% of people said they found mortgages confusing;
  • Credit cards were the least confusing product – 40% of people said they were not at all confused by credit cards.

The study was developed by the University of Bristol and Confused.com, which covers a cross section of 6,000 UK residents. It explores how people feel about modern life and how they cope with its demands. The findings have been used to create a new website http://www.confusednation.co.uk which helps baffled Brits by providing clarity on confusing issues.

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Why Being Bad can be Good

by Magical Penny on August 1, 2010

I’m still enjoying my holiday, singing with friends, so long term reader and friend Andrew Knight has written a brilliant guest post about why being ‘bad’ can be good. The great thing about this post is I know Andrew has implemented every one of these tips himself to better provide for his family.


Did you know that one third of us have on average only £500 in savings?

No? Well, would you be surprised to know that one half of us in the UK have no savings at all?

This leaves one-sixth of us with either a steely determination to save or an otherworldly ability to squirrel away every last penny.

But does this mean those who of us who aren’t in this one sixth of savers should just give up and drown our sorrows buying over-priced goods our under-valued incomes shouldn’t really allow?

No!

You should listen to the pearls of wisdom in the blog for savings tips and ways to keep mental focus high but you should also hear the often over-looked statements to tailor your savings to you.

And if you are a rubbish saver with an attitude more akin to an open flood gate during a financial storm there are a few other things you can do to improve your networth, which is afterall the real aim of saving.

Firstly,

LOYALTY DOESN’T PAY

Another question for you, how happy are you in your job? I mean really, does it thrill you? Does it stimulate you? Or is it just a means to an end?

And if you’re not happy why are you sitting there?

Did you know that only 45%/49% (US/UK) of people are satisfied in their role with satisfaction dropping significantly for 16-34 year olds?

With the average UK salary hovering around the 21k mark are you getting what you deserve?

Forget Loyalty, get your CV up to scratch, practice your interview skills and search for that higher paid role. You are worth more than society tells you, but more importantly, you are worth more than you give yourself credit for.

Moving jobs can be scary but often employers look for nothing more from you than what you can do for them. At times of financial pressure the hard work you’ve done and your optimistic attitude will mean nothing if you are surplus to requirement. Turn the tables and take control, if you are important don’t just stick with your job, look for another one and be vocal about it (to the right people) as long as you put your message across gently and tactfully you’ll appreciate it around salary review time.

Please note you must be very confident and very tactful when playing the ‘I may leave’ game because if you fail your employer may realise they just don’t need you anymore.

A higher income, especially a large increase in income makes saving much easier as you can allocate part or all of the increase in pay to savings and you won’t feel the change.

NOTHING FOR NICEY NICEY

How often do you check your bills? Do you ever speak to your providers? Do you blindly accept increases because that’s ‘just what happens’?

Review your home insurance annually; do you need all the cover they automatically offer? Do they say they’ve given 40% discount for staying with them but it’s still more expensive than other insurance on the market?

Do you fear winter and your gas bills? Do you really understand the pence per kilowatt hour of electricity? Probably not.

Is your rent up for renewal? Or your mortgage deal ending?

In all these cases and more you should not role over and accept changes. You need to don your armour and prepare your fighting face ready for the battle ahead.

As your situation changes you should check your insurances and get rid of what you don’t need. Throw in a threat to leave as well as quotes from a few other providers and your current provider will probably lower their prices. Feel free to feign ignorance or get angry, whatever works for you, but understand that all insurance providers have an unadvertised lower retention tariff.

Gas and electricity is needlessly complicated but price comparison websites help out. Again often your own provider has a lower tariff which they’ve not told you about (or they have in the unread junk mail at the bottom of your bin). I moved to a tariff which saved me 6% annually by just one phone call.

If your rent is up for renewal you’re in a position of power. If you’re in a place that is swamped with rental properties which no one is taking (such as inner city new-builds) ask for a lower price for your continued presence and you’ll often get it.

Mortgages are much more complicated but it’s almost always the case that the deal and provider you started with wont be the best to continue with when you go for renewal so shop around for a better rate. However in the case of a mortgage it may actually be better to just pay more to save more. Just £90 extra per month on my mortgage takes 10 years away from my term meaning I can get to mid-life hard-core saving earlier!

AND FINALLY…

So in conclusion a positive mental attitude to saving is only part of the route to financial success. Add salary increase and cost decrease to the mix and you can open up ways to increase your networth to a brighter financial future.

Get rid of ideas of loyalty, practice your scary phone voice, step out of your comfort zone, learn that you can do the wrong thing for the right reasons and ultimately…

Be a bit bad for goodness sake.

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Magical Penny 6 Month Anniversary!

by Magical Penny on July 30, 2010

Six months ago Magical Penny was just an empty blog template waiting to come to life.

It’s been an amazing journey so far and I’m honoured to have you as a reader – I really appreciate that you’re here today, particularly as there are so many amazing things to read both online and in the off-line world.

Over the last six months I hope you’ve found Magical Penny helpful in working out how to stay on track to reach your own goals, whatever they may be, and that you’re beginning to think of investing as not as scary as you may have first thought.

I’m currently away from home doing one of my favourite things in the world – singing with friends -but when I return I’m planning to celebrate this blogging milestone in style with lots of fresh content and give-aways and prizes for those of you on my newsletter list so if you’re not on it already, sign up today!

Have a wonderful weekend and thanks again for being part of Magical Penny.

Other Great Reads for the weekend

Carnival of Personal Finance #267 at Beating Broke

Carnival of Money Stories #64

Check out the festival of frugality magazine edition @Winformatics http://bit.ly/8X95dI

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Variable Rate or Fixed Rate Home Loans? -Part 2

by Magical Penny on July 28, 2010

Buying a house is something I think many people rush into without realising the implications of making what likely is the most expensive thing you’ll ever buy.

It’s a more advanced financial topic that Magical Penny will be exploring in the coming months. However for those of you who are about to buy a house or are considering refinancing my friend Alban has written a 2-part guest-post on one of the more important aspects of buying a home: financing.

Part 1 can be found here

Today in part 2 Alban looks at Fixed Interest Rates:

Note: This is US-centric article but those of us in the UK will still get a great deal of value from it. The UK mortgage market is mainly variable-rate offers. Fixed rates are available but longer terms are much harder to find than in the US.

Over to Alban….

Fixed Interest Rates

Many lenders will allow you to choose a fixed interest rate period which you are comfortable with and this could be from as short as one year, up to the full 30 years of your loan term. If you have taken a look at official interest rates and can see that they are at one of their lowest points then you could benefit from locking in a fixed interest rate on your loan to keep your repayments lower as well. Just keep in mind it is not always the best time to choose a fixed interest rate loan because official rates follow a cycle and may be low to encourage you to spend locally, however rates rarely stay low for very long and will be readjusted to standard levels.

Advantages of a fixed interest rate home loan:

  • Once you apply for and settle your fixed interest rate home loan rates will remain the same for the entire term we have chosen. This means that your repayments will also stay the same, allowing you to manage your budget into the future without having to worry you will need to dip into your emergency fund just to pay the mortgage. If you like to be able to accurately plan your finances, or if you need to stick to a tight budget then knowing exactly what your repayments are going to be throughout your fixed rate term can offer you the stability you are looking for.
  • Also because you are agreeing to pay a slightly higher interest rate in exchange for their monthly mortgage repayments you often need a lower down payment and rather than having to pay 10% or 20% deposit you may only need around 5% of the purchase price to secure a fixed interest rate loan.

Disadvantages of a fixed rate home loan:

  • If you decide during your fixed rate term that you want to refinance your home loan you can be charged much higher break costs to exit a fixed rate home loan than you would be on a variable-rate loan.
  • Also if you fix when interest rates are not at their lowest, when they start to decrease on their cycle then you will still be paying a higher interest rate and a higher loan repayment.

How To Choose A Fixed Interest Rate

Benefiting from a fixed interest rate home loan is all about making sure you fix at the right time. You want to fix when rates are at their lowest for when they have just started to rise from the bottom of the cycle. At the same time you need to make sure to shop around because each lender has their own opinions on how fast and how far interest rates are going to rise and fixed interest rate offers can differ significantly so take the time to find the lowest rate.

The term you choose depends on when in the interest-rate cycle you fix. Three to five-year fixed interest rate terms are often of the most benefit because if you fix for a shorter period than this you may be paying the higher fixed interest rate without seeing much protection from rises during this time and if you fix for longer you may miss out when interest rates begin to fall again. You can also choose a fixed interest rate term based on your circumstances and your future and you may choose a shorter to medium-term fixed rate until you have built up your savings account again after making your down payment on your loan, or until you are able to move ahead in your career.

Understanding the differences and benefits of both variable and fixed interest rates is just one part of your home loan comparison because you now need to look at your budget, your future and the interest rates on loans on offer from each lender.

Alban is a personal finance writer at Home Loan Finder, where he advise people on the best fixed rate home loans

Thanks Alban for guest-posting.

If you would like to offer a new perspective to Magical Penny readers do get in touch: adam AT magicalpenny.com

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Variable Rate or Fixed Rate Home Loans? -Part 1

by Magical Penny on July 26, 2010

Buying a house is something I think many people rush into without realising the implications of making what likely is the most expensive thing you’ll ever buy.

It’s a more advanced financial topic that Magical Penny will be exploring in the coming months. However for those of you who are about to buy a house or are considering refinancing my friend Alban has written a  2-part guest-post on one of the more important aspects of buying a home: financing.

Note: This is US-centric article but those of us in the UK will still get a great deal of value from it.  The UK mortgage market is mainly variable-rate offers. Fixed rates are available but longer terms are much harder to find than in the US.

Over to Alban….

There are many variables to repaying your home loan easily and saving money along the way. The loan amount, deposit amount, loan features and lender service all impact on your journey as a mortgage holder, but the aspect of home loans which many people are most focussed on is their interest rate, so focus your attention here on the advantages of fixed and variable interest rates and learn how to make an informed decision on one of the most high profile of loan features.

Home Loan Features

Home loans are a competitive market and where there was once a great divide between variable and fixed rate loans, the gap is closing. Variable interest rate loans, also known as adjustable rate mortgages, were typically the sole domain of offset accounts, redraw facilities, and were the only loans which allowed you to make additional repayments. In taking the time to shop around for a home loan you may be able to find a loan with your choice of interest-rate and features whether you are after a fixed or adjustable loan.
The interest rate is such an important feature to consider, because while you may now be able to get traditionally variable rate loan features on a fixed interest rate, the difference between the rates on each loan can differ significantly. For example of the current average adjustable interest rate is 4.19% where the average fixed-rate is 4.88% and this can mean a difference of hundreds  a month in your repayments.

Adjustable Interest Rates

Adjustable interest rates seem to be the better option at the moment, and historically variable rates tend to be between 0.5% and 1% lower than an equivalent fixed interest rate. At the same time you need to consider the advantages and disadvantages of a variable interest rate loan according to your own circumstances.

Advantages of variable interest rate home loans:

  • It is common to be able to find low introductory interest rates on a variable rate loan. These lower rates may be charged for anywhere from one month to 5 years and can save you hundreds as you settle into the routine of repaying your new loan.
  • Even at the end of an introductory period your adjustable interest-rate can continue to save you money on your loan if official interest rates stay steady or drop. This is because variable interest rates are adjusted according to changes made to the official interest rate to manage the economy, as well as based on your lender’s decision on whether to match official rate movements.
  • When choosing the type of variable interest rate you can choose one which is adjusted just once a year, and is also capped per year and for the life of the loan. This means that while you will be able to enjoy decreases in your home loan interest-rate you will also know the maximum amount your rate will rise to as your rate may be capped at 2% per year and 6% for the life of the loan so if you apply for an adjustable rate loan at the current 4.19% you know that over the life of your loan you will never be charged much more than 10% interest but during times of falling interest rates you can make considerable savings.

Disadvantages of having an adjustable interest-rate:

  • Your home loan interest rates can be adjusted periodically depending on your lender and may vary each month, quarter, year, three years or every five years.
  • An adjustable interest-rate varies depending on the index and the margin. The index is a measure of official interest rates, and the margin is the extra amount which your lender adjusts. Therefore you could see a rate adjustment if official rates affect your index rate, or your repayments may increase if your lender adjusts their margin. At the same time while the index rate may move down your adjustable interest-rate may not adjusts downwards and this is something you will need to check with your lender.

How To Decide On A Variable Interest Rate

It is easy to be attracted to an adjustable rate mortgage because of a low introductory rate and lenders know this. That is why if you are applying for an ARM with a low rate initially, you may have to specifically ask your lender to see their annual percentage rate as this is the rate your loan will revert to after the introductory period.

It is also important to remember that when the economy is uncertain lenders will try and take advantage of this panic as well, because many people look to fix their interest rates during unstable times and so fixed rate loans tend to be much more expensive. As a result if you are able to leave your loan at a variable rate during such times and ride out any instability you can save hundreds or even thousands. To help you decide whether you can weather such a storm calculate your repayments using a stress rate of around 2%. The stress rate will show you how much your repayments would be if your adjustable rate rose by 2% and this is a common calculation used by lenders to assess your suitability for a variable rate loan. You can then take your new higher loan amount and see how it would fit into your budget to help you decide whether a variable rate home loan is right for you.

Since your variable interest rate could be on the rise in the future, think about what else might be in your future. Things like car loans or private school expenses can change your budget dramatically and if your circumstances are likely to change make sure you can budget for this as well. Many people who choose an adjustable interest rate loan do so to take advantage of a low initial interest rate, because they know that their income will be increasing in the future. Therefore if you are a first home buyer or plan to excel your career then you may be able to afford to slightly higher costs of a flexible home loan rate, as well as benefit from falling rates in the future.

Alban is a personal writer. He provides information on property investment and helps people choosing the best refinancing loan

Check back on Wednesday for the advantages and disadvantages of fixed rate loans.

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Only Today

by Magical Penny on July 21, 2010

Life is made up of thousands of ‘todays’

And today is always busy isn’t it?!

If you are to be successful at anything, whether it’s growing your pennies or becoming more productive, it’s what you do consistantly every day that will make all the difference in the world.

We make thousands of decisions each day and we find ourselves prioritising one thing over another all the time.

What do you prioritise?

Sometimes you might be tempted to put things off because you want to do a ‘proper’ job of them;  to give the tasks the time they deserve. The trouble is you risk putting off important tasks:

Maybe you’re waiting until your next payrise to sort out your finances, or you’re waiting until you have an empty weekend to start reading that book that will help you in your career?

What I’ve found, however, is that it’s too easy to put things off until you feel ‘ready’. I know I have lost countless opportunities in the past because I’ve not felt ‘ready’. I bet you have too.

Priorities

To use a very meta example, I’ve made it a priority to work at being a personal finance blogger:

Not just when I have a bit of spare time, but consistantly. I’m writing every day and publishing to this site three times a week. Today’s post is a perfect example of  such a priority (given my current workload the time spent writing this is a priority over sleep).

But what about you? What are your priorities and are they really your priorities?

Do they get pushed aside when life gets busy? Or how about your financial plans and goals? Are they regularly missed due to constantly changing circumstances or spending whims?

The true test of a priority is if you answer yes to the question “Am I working towards this priority today?” Say yes often enough and your priorities will begin to shape your life the way you intend them to.

None of us have all the time in the world.

Only today.

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