One result of the recent rises in interest rates has been a spate of launches of new limited-issue, fixed-rate bonds. Several banks and building societies now offer savers a tempting deal with some of these bonds paying 7 per cent or more a year before tax (worth 5.60 per cent after 20 per cent savings tax). The only catch is that savers must be willing to tie up their money for between one and three years.
Until recently, for example, Northern Rock, which has earned a reputation for offering top-paying bonds of this type, was offering a mouth-watering 7.50 per cent a year (6 per cent) on a minimum investment of £1,000. Savers can choose a fixed term of one, two or three years and opt for monthly income, though the rate payable fell to 7.25 per cent (5.80 per cent) if you took this option.
Woolwich and Bristol & West are also regularly among the leaders on these fixed-rate bonds, and building society members should also check what their society offers. Nationwide, Yorkshire and Britannia all run limited-issue bonds exclusively for their members, typically those of at least three years' standing.
Woolwich's latest offerings include fixed-rate bonds paying 6.65 per cent (5.32 per cent) annually for two years or 7 per cent (5.60 per cent) a year for three years on a minimum deposit of £500. Savers who choose to take income monthly will get slightly lower annual rates but the two-year deal is better than anything available on longer-term bonds. The best five-year fixed-rate bond is from Norwich & Peterborough, at 6.90 per cent a year (5.52 per cent).
Nor is it necessarily worth waiting for improvements. Analysts expect Bank of England base rates to rise further this year, but increases are already priced into the rates available on one, two and three-year bonds.
If you fix now, chances are you will be doing so at close to the top of the market. Dharshini David, UK economist at HSBC, says: 'We expect base rates to rise to 6.5 per cent by late spring but to fall to 6.25 per cent by the end of the year. Inflation is low so there is no need for aggressive rises in interest rates. These fixed-rate bonds from banks and building societies could be at or very near their peak.'
At Merrill Lynch, UK economist Paul Turnbull agrees. 'Base rates are near their peak but might rise to 6.25 or even 6.5 per cent.
'We are predicting base rates at 6.25 per cent at the end of this year and 5.75 per cent 12 months later,' he says.
Higher-rate taxpayers will, howeve, do better still with National Savings Certificates. The two-year third issue fixed-rate certificates pay a tax-free 4.75 per cent a year. This is the equivalent of earning 7.92 per cent before tax for higher-rate taxpayers, which cannot be bettered in the private sector. You can invest up to £10,000 in this latest issue, on top of any money you re-invest from any existing National Savings Certificates you have due to mature while this issue is on sale.
But be careful with escalator bonds, launches of which are currently also popular with banks and building societies. These pay a fixed rate of interest each year for the term of the bond. Rates start at a lower level than on straight fixed-rate bonds but rise each year throughout the term. Escalator bonds are a good marketing ploy for providers as they can quote top rates of 7.5 or even 8 per cent before tax. But these rates are not payable until the final year of the bond.
The two-year Leeds & Holbeck escalator bond, for example, pays 6 per cent (4.80 per cent) in its first year and 8 per cent (6.40 per cent) in year two on a minimum deposit of £100 - an average of 7 per cent (5.60 per cent) a year. But you have to put up with less income in the first year to earn more in the second.
On Cheltenham & Gloucester's three-year bond, the rates are 6.75 per cent, 7 per cent and 7.5 per cent before tax in years one, two and three respectively - an average of 7.08 per cent (5.65 per cent) a year on £500 or above. West Bromwich (minimum £2,500) pays between 6.5 and 8 per cent before tax, an average annual rate of 7.25 per cent (5.8 per cent) over two years.
A word of warning. Make sure you are happy to ride out the full term of a fixed-rate bond before your invest. Most bonds levy hefty interest penalties - 90 days' loss of interest is typical - on early withdrawals.
This is taken from the April issue of Money Observer, on sale at newsagents price £3.50. For 12 issues at £31.97, a saving of £10, call 0870 870 1324 and quote reference MYDG001.
