FOOL'S EYE VIEW
Five Financial Masterstrokes

By Alison Hunt (TMFAlly)
September 20, 2005

A growing number of us are becoming concerned regarding our financial futures. Every day seems to bring news of another pension scheme fiasco and the only way it seems we can help to protect ourselves, as all regular readers of the Fool realise, is to get financially organised. So if you fancy getting your finances in gear and setting yourself and your family up for a more secure future, make the most of these financial techniques. They can help you get your finances on track, long term, and save you some money along the way.

1. Obliterate that mortgage

What's the biggest bill you have to pay every month? Chances are, if you're a homeowner your answer will be "the mortgage". How much extra cash would you have if that bill were obliterated?

Yes, I know you're probably thinking that mortgages are set at a 25-year (or longer) period for good reason. After all, our houses often cost hundreds of thousands of pounds - no one expects to pay them off particularly quickly. Well, unless you should suddenly come into a vast amount of cash or your earnings suddenly sky rocket! But that's a very old-fashioned way of thinking that stems back to the dark old days when we all paid our lender's standard variable rate and stayed put for 25-years until it was all paid off. Times have changed! Today's modern, flexible mortgages calculate interest on a daily, rather than yearly basis as was seen ten or more years ago. As a result, every pound we can plough into it starts working to reduce the debt immediately. And every single pound really does count.

Consider a 25-year, £120,000 repayment mortgage at 5%. Monthly payments will be roughly £701, and the borrower could expect to have paid around £210,450 at the end of the term - £90,450 in interest.

Now, if this borrower could afford to overpay by just £50 each month, the amount to be repaid changes significantly. The total amount repaid would reduce to around £197,840 - saving over £12,600 in interest. However, the borrower would also shave over three years off his mortgage term, meaning he'll be mortgage free in less than 22 years. Double this overpayment to £100 and nearly £22,000 would be saved, with the mortgage being paid off in less than 20 years.

So get to work; phone your lender and ask if your mortgage is flexible and by how much you can overpay each year. Then work out how much you can afford and write to your lender to ask for your monthly payment to be increased. Then sit back and watch that balance tumble until it's finally all gone!

Find a better mortgage deal in our Mortgage Centre.

2. Earn interest on your money, tax-free

How many times do you pay tax on your cash? Well, most of us will be paying some form of income tax on our salary, which has usually been taken before we even see the money. But then, and a lot of people seem to forget this, any money kept in a savings or current account is further taxed by another 20%. Then, higher rate taxpayers must declare whatever interest they've earned on their tax return so the taxman can take another 18%. So a higher rate taxpayer with an account paying 3%AER is actually only really earning 1.8%, with a basic rate taxpayer earning 2.4%. And when you take inflation (RPI) at 2.4% into account, you can see that we could actually be losing money!

So what's the solution? Simple: try to earn your interest free of tax wherever possible. One of the easiest ways to do this is via your ISA allowance. Each year, everyone over 16 is entitled to save up to £3,000 in cash and invest a further £4,000 (if you're over 18). Alternatively, if you know you'd like to invest more than £4,000 you can choose a maxi-shares ISA and invest up to £7,000. Cash ISAs are just like savings accounts; except for the fact the interest paid is not taxed. So whilst a higher rate taxpayer with £3,000 in a savings account paying 5% would only see £90 in interest each year, he'd be keeping the full £150 if he'd stashed his cash into a mini-cash ISA.

And don't forget you have a shares ISA allowance as well. If you've never dabbled in the stock market, consider paying a set amount into a cheap index tracker - the potential returns are far higher and the low costs of the fund mean, importantly, that you get to keep more of your profit. But remember, don't invest any money that you may need in the next five or ten years.

Find out more about ISAs in our ISA Centre or switch to an account paying up to 5% in our Savings Centre.

3. Get your head out of the sand and organise your retirement pot!

Hands up if you didn't realise the UK is in a bit of a pensions mess at the moment. No hands raised? No, I'm not surprised. It seems that most of us are facing the prospect of a Basic State Pension that'll just about cover our tea bags and custard creams!

Unfortunately, with all the pension uncertainties it's becoming clear that if we don't want to work until we physically drop but still have a modestly comfortable retirement, then we're going to have to do something about it, ourselves. And that means making a retirement plan now. So don't ignore the problem - get your head out of the sand (you know who you are!) and listen up.

Firstly, if your employer offers a pension scheme to which it contributes, and you haven't already joined, seriously consider doing so. After all, do you really want to turn down free money? Then try to pay in as much each month as you can afford. A thirty-year old earning £25,000 p.a. and paying 5% into his pension (matched by his employer) would see his pension pot grow by £2,500 each year. But thanks to basic rate tax relief, this will only really cost him £975. And when he comes to retire at 65, he should hopefully expect a pension pot of over £350,000 (assuming a return of 7% after charges), enough to fund a modest retirement. And clearly, the earlier you can start saving, the better.

Remember, higher rate taxpayers can claim back a further 18% via their tax return. And don't worry if you're not able to take advantage of a company pension scheme, you can set up a cheap stakeholder pension very easily yourself and still benefit from the tax relief (even if you're not working and so don't pay tax!). What's more, pensions are by no means the only way to build up a retirement pot. Many people choose to invest long term in index trackers or managed funds via their shares ISA allowance, either instead of, or alongside a pension. Obviously, whichever method you choose to use, make sure you're aware of the charges first as they can drastically erode your returns.

Find out more about pensions or index trackers.

4. Take advantage of cheaper borrowing

Of course, before putting any of the other tips into practise you should have first paid off your debts. After all, what's the point in earning 5% gross on your savings if you have debts racking up interest at 12%?

One of the best ways to do this is to take advantage of 0% balance transfer credit cards. By transferring debt from loans or credit cards to a 0% card you can gain up to a year, interest free. Then, by making a concerted effort you can aim to pay off that balance before the interest free period expires whilst paying no interest!

Alternatively, consider switching an expensive loan to a more competitive deal. Top of the Best Buy tables at the moment is Moneyback Bank, offering a typical APR of just 5.5%. Check out the rate you're paying and if it's not good enough, switch.

You can apply for a number of 0% cards in our Credit Card Centre, or a loan with Moneyback Bank in our Personal Loans Centre.

5. Re-mortgage regularly and consider offsetting your mortgage

With mortgages taking pride of place as the biggest debt most of us have, it's not surprising that this is the area where we can the most money. And of course, one of the easiest ways to tackle this is to pay as little interest as possible. Overpaying was one way of doing this, but another involves re-mortgaging promptly when introductory rates expire. The difference between the ultra-low rate you signed up to and the Standard Variable Rate (SVR) you'll be moved to can be over 2% and quickly negate the savings you've made if you take too long to switch. Payments on a £120,000 25-year, repayment mortgage at 4.75% can increase by a whopping £145 each month, if you are switched to your lender's SVR of 6.75% - and that's not to mention how much extra interest you'll pay over the term of the mortgage!

Offsetting your mortgage also provides a method to pay off your mortgage more quickly. Offset (or current account) mortgages allow us to combine all of our accounts together to reduce the interest on our mortgage. Instead of earning interest on our savings and current accounts, for example, this money is used to save interest on this portion of our mortgage. As interest is calculated daily, this can significantly affect the amount of interest we are charged and so result in us being able to pay off our mortgage earlier. The money in our savings and current accounts is still available to be used if and when we should need it, indeed many offset accounts allow you to view these separately, and thus avoid the prospect of seeing a current account balance of minus £100,000! And some accounts will allow you to include any loans you may have, effectively reducing the rate of interest payable.

Offsetting is particularly useful if you have a lot of cash savings. Mortgage rates for offset mortgages tend to be slightly higher too. Overpaying, however, will generally have more of an overall effect than offsetting can.

Find out more about re-mortgaging and offsetting in our Mortgage Centre.

So there you have it, five financial masterstrokes that can get your finances on track and allow you to plan for a brighter financial future!