End of Funding for Lending and the Term Funding Scheme: hope for cash ISAs
- The past year has been the worst on record for cash ISAs.
- But there are signs we may have reached a turning point, as rates have started to rise.
- Funding for Lending and the Term Funding Scheme are drawing to a close, which could be just the shot in the arm the ISA market needs.
Moneyfacts figures out today have revealed that this is the worst year on record for cash ISAs – with average returns at a historic low of 0.93%. The full report is available here.
Sarah Coles, Personal Finance Analyst, Hargreaves Lansdown:
"There has been a dark cloud hovering over the cash ISA market for years now. Record low interest rates from the Bank of England, alongside the availability of cheap funding from central government through the Term Funding Scheme and Funding for Lending, have conspired to keep ISA rates at rock bottom. However, these funding initiatives are drawing to a close, and with the Bank of England base rate starting to rise, there are three reasons to be cheerful about the outlook for cash ISAs."
1. Cheap government lending is disappearing
One major factor depressing cash ISA rates over the past few years has been the availability of cheap money from the government – through Funding for Lending and the Term Funding Scheme. Banks could borrow from central government at close to base rate, so there was no need to offer competitive savings rates in order to attract money from savers.
However, with the Funding for Lending scheme ending at the end of January, and the Term Funding Scheme coming to a close at the end of February, unless there are major new initiatives announced by the Bank of England, this could change the environment markedly for banks. In theory, over time, it should put gradual pressure on them to raise savings rates, as they turn back to savers as a source of funding.
2. Average rates are already on the rise
This should support a rising trend that has already begun. The Moneyfacts figures showed a small recovery in average ISA rates over the past 12 months. Returns were at their worst in January 2017 at 0.82%, but have since returned to 1.09% and have risen for 12 consecutive months.
The rise in the Bank of England base rate in November played a major role in these increases, so the fact that the market expects two more in the next three years should help push rates higher again.
3. You can do much better than average
Whatever happens to the wider market, you can always do better by shopping around. At the moment, the average return on a cash ISA is just 0.93%, but the best easy access cash ISA rate that’s widely available offers 1.16% while the best over three years is 1.86% and the best over five years 2.11%. If you’re saving for a house deposit for the short term and want a help to buy ISA, the best widely available rate is 2.53%.
Shot in the arm
Rising rates will in turn increase the appeal of cash ISAs over and above cash savings accounts, because savers may find themselves breaching the personal savings allowance.
The introduction of this allowance in 2016 was a serious blow for cash ISAs, because it meant that basic rate taxpayers could earn £1,000 on their savings before being subject to tax, and higher rate taxpayers could make £500.
Assuming you made 2% on a savings account, it meant a higher rate taxpayer could save £24,800 before being subject to tax, so many were happy to leave their cash in savings accounts, which are currently offering slightly higher rates than cash ISAs.
Even if rates were to stay exactly where they are, there’s a strong argument in favour of cash ISAs, because they offer long term protection from tax. Using your ISA allowance this year permanently shelters the money from tax, whereas relying on the Personal Savings Allowance means putting your faith in a policy that could change at any time.
If rates were to rise within reach of 4%, cash ISAs become even more valuable: a higher rate taxpayer would only be able to save £12,300 before being subject to tax. If they were to follow sensible financial advice to save between 3 and 6 months’ worth of expenses as a cash safety net, they could easily breach the limit. In order to avoid paying 40% tax on a portion of their savings, therefore they would need to turn to back to cash ISAs.