Fixed rate versus variable rate savings accounts
Find out the pros and cons of each type
Fed up with low interest rates on your savings? You’re not alone! With Bank of England interest rates so low, many savers are looking at different ways to get a better return. Is a fixed rate savings account the answer?
How variable rate savings work
Most savings accounts are variable rate. That means that the interest rate that the bank pays when you sign up isn’t guaranteed to last. The bank can reduce the interest rate – or increase it.
There are rules in place which mean that the bank has to tell you – in advance – when it’s going to reduce the rate. But it does mean that you have to check the interest rate from time to time and be prepared to move your money if you see a better rate.
The good thing about variable rate savings accounts is that they are very flexible, especially easy access ones. With an easy access variable rate account, you can take money out and top it up whenever you want.
Fixed rate accounts
Fixed rate savings accounts (often called ‘fixed rate bonds’) and fixed rate cash ISAs generally pay a higher interest rate than variable rate accounts. The longer the fixed rate term, the higher the interest rate tends to be. For example, an easy access savings account may pay 1.5% interest, whereas a one-year fixed rate savings account may pay 2%, and a five-year fixed rate savings account may pay 2.7% interest.
So, if you paid £1,000 into that easy access account at the start of the year, your savings would be worth £1,015 after 12 months. If you did the same with the one-year fixed rate account in the example, it would be worth £1,020, and with the five year account your £1,000 would be worth £1,027 at the end of 12 months. The interest rates I’ve used are only examples, so you may be able to earn more – or less – in interest.
You can find more about the different types of fixed rate savings accounts in this article.
Fixed versus variable rate accounts
The difference in interest in those examples above, between the easy access savings account and the five-year fixed rate savings account, only added up to £12 in the first year on £1,000. So, if you have a couple of thousand pounds in savings, moving to a fixed rate savings account may not be worth it (see the downsides in the next section).
But if you have £10,000, the difference in the interest multiplies (obviously!). And with savings accounts, after the first year you start to earn interest on interest, so the difference in the interest you earn increases.
Downsides of fixed rate accounts
So what are the downsides of fixed rate savings accounts that you need to be aware of? Here are the main ones:
- You usually have to leave your money in the fixed rate account until the term is up. This is the period the interest rate is fixed for and it’s typically between one and five years.
- Most fixed rate bonds won’t give you early access to your money at all. Fixed rate cash ISAs may let you take money out early, but you’ll lose some interest.
- You can’t just top up your fixed rate account as and when you like. Normally there’s a limited period when you can pay money in. So, if you prefer to save a regular amount from your salary or earnings, a fixed rate savings account won’t work for you.
- You may find your savings are locked into a fixed rate that looks less competitive if interest rates in general rise.
Now you know a little more about the benefits of fixed rate savings, you can work out if they’re right for you. And it doesn’t have to be all or nothing. Depending on your situation, it may suit you to split your savings so you keep some in an easy access account and some in a fixed rate account.
Before making financial decisions always do research, or talk to a financial adviser. Views are those of our mentors and customers and do not constitute financial advice.