Financial inertia makes losers of consumers

Widespread aversion to dealing with financial institutions and their own financial affairs means that consumers often fail to maximise the interest they could be earning on their savings and minimise the interest they could be saving on their borrowings

Constant shopping around can be exhausting, especially when you can't quite remember what interest rate you're on - something of a prerequisite when it comes to comparing what's on offer.

Another common tactical error is to build up expensive, hard-to-shift debts as a result of trying to save too much.

It is a sad financial fact that the amount consumers pay in interest on their borrowings will always exceed the rate that institutions offer them for the pleasure of providing a home for their savings.

Yet consumers sometimes don't see the contradiction in keeping a rainy day sum stashed away in a deposit account paying a paltry rate of interest and, at the same time, regularly racking up interest charges at a rate of 16.9 per cent because they have failed to clear their credit card bill.

"People who are saving through Special Savings Incentive Accounts might find that they cannot pay off their credit card in the allotted time because of the money they have going into the SSIAs," says Mr Michael Culloty, regional development officer for the East region at the Money Advice and Budgeting Service (MABS).

But it is, he notes, a problem that only those who could afford to commit to the five-year SSIA scheme encounter.

"One of the big problems the people who come to us have is that they can't afford to save and are forced to borrow at very exorbitant interest rates from moneylenders," Mr Culloty says.

For those who do have sufficient cash to spare or who are cutting back on luxury goods to build up a nest egg, opening a savings account will seem like the financially sensible, prudent thing to do.

According to Mr Michael Kiernan of online broker MyAdviser.ie, consumers will sometimes pay high interest on credit cards rather than dipping into a savings account that is earning a much lower rate.

People sometimes feel that if they use their savings in this way, it would be too easy not to put the money back into the account to make up for their emergency dip.

"Obviously the smart thing to do is to have the discipline of saving while at the same time minimise the cost of the borrowing, but it is hard to do," says Mr Kiernan.

"A balance is needed and if you have significant debts and longer- term money sitting on deposit then the best advice is to reduce the debt."

Taking higher risks with savings - opting for equity-linked investment products with potentially higher returns - is not for everyone and can result in significant losses, he says.

Meanwhile, homeowners may simply view their mortgage as a separate concern from their savings habit. "It is on its own set of tracks and you don't mess with it. The value of the mortgage repayments compared to the value in the savings is never considered," says Mr Kiernan.

Keeping money languishing on deposit while they are paying 3 or 4 per cent on their mortgage debt makes no sense "from a purely mathematical point of view", says Mr Liam Ferguson of financial intermediary Ferguson & Associates.

Homeowners can make huge savings on interest simply by making small regular overpayments or larger once-off lump sum overpayments on their mortgage.

For example, a couple who borrowed €300,000 over 30 years could save €6,843 in total interest payments and knock nine months off the term of the mortgage by making a lump sum overpayment of €5,000 four years into their mortgage.

If they make a regular overpayment of just €40 a month for the full term of their mortgage, they could save €9,587 in total interest and cut short their mortgage by one year, five months.

If the short-term pain caused by sacrificing another €40 from the household budget is too much to bear, then homeowners should first take a look at what savings they could make by remortgaging.

Ulster Bank is currently running a free switch offer for new customers who stay with them for five years.

Happily, at 3.15 per cent, the lender is also offering the best interest rate available without any preconditions attached. The worst is Bank of Ireland's standard variable rate of 3.6 per cent.

On a €250,000 mortgage with a 25-year term, the Bank of Ireland customer pays €60 a month more than the Ulster Bank customer.

If those rates were to remain the same over the lifetime of the loan, the Bank of Ireland customer would end up paying €18,000 extra in interest.

If the Bank of Ireland borrower switches to Ulster Bank in the sixth year of their mortgage, but ploughs the extra €60 a month they have in their pockets back into their mortgage as regular overpayments, they will save a further €5,248 in the total interest they will pay and clear their mortgage a year and a quarter early.

However, people are often reluctant to overpay their mortgage, because they want to be able to spend their money should the need or temptation arise.

"If you pay money off your mortgage, it's hard to get back out," says Mr Ferguson. "If people have built up €30,000 in savings, they want it to be accessible, but they might find that if they pay it off their mortgage, they have to apply for a top-up mortgage if they need the money. It's cumbersome."

One way around this problem, he notes, is to opt for a current account mortgage. First Active is the only lender to offer this product, under which the balance in the homeowner's current account is deducted from the mortgage debt, cutting the interest payable.

The interest owed is calculated on a daily basis, so customers benefit immediately by crediting money such as their salary to the account.

Any money left in the account at the end of the month after day-to-day expenditure and the normal monthly mortgage repayment is classed as an overpayment and reduces the balance of the mortgage automatically. These overpayments remain accessible at any time or can be used to shorten the term of the mortgage.

Mr Ferguson suspects that the current account mortgage, already building in popularity, will become even more popular once the main batch of Special Savings Incentive Accounts (SSIAs) mature in 2007.

If a person has contributed the monthly maximum of €254 or close to it under the savings scheme, at maturity they will be able to indulge in a guilt-free shopping spree and still comfortably have a lump sum of €15,000 that they could use to whittle down their mortgage.

Under a current account mortgage, these SSIA proceeds would remain readily available to homeowners should they want to reward themselves for their diligent saving at a later stage.

But there are other, potentially more lucrative, options for the SSIA holders or indeed anyone looking for a home for a lump sum.

Mr Ferguson suspects that SSIA bonanzas that aren't spent on the forecourt or down the travel agent will be used in three ways: to pay off mortgage debt, to invest in any tax-efficient scheme the Government launches and to boost pension funds.

The tax relief on pensions will make using the lump sum to kick-start a Personal Retirement Savings Account (PRSA) or make additional voluntary contributions (AVCs) in the case of existing pension scheme members very attractive.

The example of Emma detailed in the panel opposite shows that investing in a pension could reap more financial rewards than paying down a mortgage.

But this will depend on the rate of tax the homeowner pays, their age, how far along they are into their mortgage term and the actual investment growth.

Unfortunately, many SSIA contributors will not be in a financial position to choose whether to pay off their mortgage or save for retirement with their matured fund, because they have already set aside the money to pay off car loans and personal loans they have built up in the meantime.

Paying interest on unsecured debts at rates of at least 6.9 per cent means that these SSIA holders could effectively be negating the once-in-a-lifetime benefit of the scheme's 25 per cent Government bonus on contributions.