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A savings account is just a place to dunk cash to earn interest and save for the future. But don't just go for the headline screaming the highest rate without first examining how it works and what the alternatives are.

Shouldn't I have an emergency fund?

It is important to have access to an emergency fund in case the worst happens, but that doesn't mean you have to actually have a pot of cash. If you pay off an expensive credit card, then keep the card for emergencies.

If nothing untoward happens then you never need to use the card, but if something goes wrong, then you could always use the card, and you'd be no worse off than had you not paid it off anyway.

A practical example of why this works: Johnny Comelately

Johnny Comelately currently has 5, 000 saved up, earning 2% interest, in case of emergency, yet he also has 5, 000 on credit cards at 18%. Thus while his savings are earning him 100 a year, his debts cost 900. Overall he is paying out 800 a year.

Now compare what happens if he pays off his debts with his savings vs not doing so:

Situation A: No emergency happens

No change. Keeping both debts and savings costs Johnny 800 a year.

Pay off debts with savings. Johnny now neither earns nor pays any interest, thus is relatively 800 a year better off, and all the new cash he puts aside can go towards genuinely saving.

Situation B: After a year he has to pay 5, 000 for an emergency roof fix

Johnny uses the savings for the emergency. This leaves him with no savings and 5, 000 of credit card debt at 18%.

Pay off debts with savings. As Johnny has no savings, he has to borrow the 5, 000 on his credit cards. This leaves him with no savings and 5, 000 debt on his credit card at 18%.

In other words, Johnny is in exactly the same position in situation B, regardless of what he does. Yet before the emergency he was 800 a year better off by paying off his debts with his savings.

So overall, whether an emergency happens or not, the best result is to pay off your debts with your savings. The only time to beware of this is if you're not assured of being able to reborrow the cash.

Usually with credit cards it's fine, as they're a readily available source of credit, but if your debt is a personal loan, there's no guarantee you will be able to get another in which case an emergency fund is sensible.

If you've got a mortgage, check if you should overpay it before saving

This is the same principle as above: if the mortgage rate is higher than the savings rate, and you can spare the cash, overpaying is a solid financial decision. However, there are possible complications, such as penalties for paying too much...

Quick questions

Will I always be allowed to overpay and is there a limit?

Whether you can overpay your mortgage or not depends on your mortgage provider and the type of mortgage you've taken out.

The vast majority of mortgages allow you to overpay, though there's usually a limit to how much you can overpay. Common limits are 10, 000 a year or 10% of the value of your mortgage debt each year.

It's also important to check how it plans to use your overpayment. Some lenders will use it to reduce the term of your mortgage, so your monthly payments stay the same but it'll be paid off quicker. Where the amount overpaid is small enough, others use it to reduce your next monthly payment, which only saves you a few days' interest.

Always check how the mortgage lender plans to use your overpayment, and if possible, say you want it to reduce the balance, and keep your monthly payments the same to really see the benefit.

Find full information on the pros and cons in the Should I Overpay my Mortgage? guide, or see how overpaying affects your mortgage with the Overpaying my Mortgage calculator.

If I overpay my mortgage can I access that extra cash again?

If you have an offset mortgage the ability to access those extra payments is usually part of the deal. An offset is where you build up savings to reduce/offset the amount of debt you pay interest on, so if you had a 100, 000 mortgage and 20, 000 in savings, you only pay interest on 80, 000.

On other types of mortgages, some flexible deals allow you to borrow back overpayments. However, this practice is far less common now for new mortgages. Check your mortgage terms carefully.

One warning: just because you've overpaid doesn't automatically mean you'll be allowed to borrow the money back in all cases. Your mortgage lender will do checks on affordability so they comply with current lending criteria. For example, you might be turned down if they thought you'd struggle to make future contractual payments they'd want to keep hold of as much of your money as they could in that case.

Have you used your 2016/17 ISA allowance? It allows you to save and never pay tax on interest

A cash ISA is simply a savings account where you never pay tax on the interest. Anyone aged 16 or over can put up to 15, 240 into their cash ISA during the current tax year.

Traditionally this was the first place for taxpayers to put a lump sum, yet the new personal savings allowance has made them a less attractive option. Read Martin's are ISAs worth it? blog for full analysis on whether or not you should open one.

Isn't my money locked away in an ISA? (That's a common myth it's not)

Just like savings accounts, there are different types of ISAs. One of the main types people opt for is an easy-access ISA. And, just like easy access savings, the money's there for you to take it out whenever you like.

Of course, you can get fixed-rate ISAs, where you put money in there for a number of years. But, unlike normal savings, even fixed-rate ISAs have to allow you access to your money, although all will charge an often hefty interest penalty if you do. Find out more about how ISAs work in the Full ISA Guide.

Are you willing to switch bank account? You can boost savings rates

Surprisingly, some banks' current accounts pay a higher rate of interest than their savings accounts these are currently the top rates available, though are under threat following recent cuts to the Bank of England base rate. Unlike normal savings accounts, you'll need to pass a credit check.

Can you put money aside each month? Consider a regular saver

This is a specific product for putting 10-500 in every month (maximum deposits vary by account). If you want to save more, combine a few. The main advantage is they tend to pay much higher rates of interest than standard deals. For more details and best buys, see the full Regular Savings Accounts guide.

Can you lock the cash away? Fixed savings give a (slightly) better return

You may want to consider getting a fixed-rate savings account where the amount you earn is set in stone over a fixed time period. However, you can't usually access the cash during that time, and even if you can, the penalties can be large.

Usually fixed rates are higher than easy access, so they can be good deals. However, if normal savings rates were to increase during that time, you'd be unable to ditch and switch to a better payer. See the full top .

Source: www.moneysavingexpert.com
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