Why are HelpToBuy ISA variable rates so much better than standard variable ISA rates?

Hibernator

Obviously the main thing about the Help To Buy product is the government bonus, but the interest rate being offered on them is magnitudes higher than that on the same provider's regular variable cash ISAs (eg Halifax: 2% versus 0.3%, Natwest: 2% versus 0.01%). What forces are at work here? Is the government subsidising the interest rate too? Some sort of competitive force with providers being strangely keen to hold first-time-buyer savings? Are the providers hoping to cross-sell their mortgage products?

colsten

It's all about providers trying to appeal to prospective mortgage customers. In addition, the amount you get the better interest rates on is severely limited, due to the maximum monthly deposit limit.

bowlhead99

colsten wrote: »

the amount you get the better interest rates on is severely limited, due to the maximum monthly deposit limit.

This.

In 'the old days', ISAs were one of the better places for your money because providers knew there was a practical maximum they would have to pay out on.

The certainty for providers that they'd only be paying on smallish balances started to drop away as the maximum you could put into an ISA increased to over £5k in 2010, almost £6k by 2013 and £15k in 2014. Many higher-paying ISAs would only allow the best rates for current year contributions rather than transfers in, because otherwise they'd face paying a good rate on £50-100k.

Also, as you were saving tax, they felt like they could get away with a generally worse rate. ISAs became even less relatively attractive with the prevalence of high interest current account deals. Banks offered them in order to hook you into a bank's ecosystem for cross-selling opportunities, and they were affordable for the banks as they only paid out on limited amounts of balance - typically lower than what could be put into an ISA. The fact that banks all allowed you to have current accounts at multiple providers (in self preservation) meant that customers could still end up with a good amount stashed away in such accounts.

And then with the government creating a large '0% starting rate for savings income' band, and later the personal saving allowance - taking many people out of tax anyway while interest rates are low - there were fewer and fewer reasons to use ISAs. For ongoing savings, 'regular saver' accounts gave great rates (again affordable for the banks as the amounts going in were restricted to a max per month). And if you wanted to be able to remove money and freely deposit it, the high interest current accounts offered that.

So in a low interest rate environment with low tax consequences of using non-ISA accounts, ISAs became quite unloved.

But with an incredibly lucrative government bonus for a first time buyer - a pile of free money - people are willing to use ISAs again; the help to buy type. The government incentive will offer free money which dwarfs what any of the banks would be willing to pay in interest over the typical two to four years hold period. So it's a no-brainer to get one if you're a FTB, but customers are not going to be too fussed what provider they use, as their real 'partner' in this particular savings venture is the government. This creates a good opportunity for the banks: a load of customers for a product which people would be quite willing to hold independently from their current accounts and day to day savings if the terms are good.

So with the above backstory, we know:

1) Banks are more willing to offer high interest rates where the amounts attracting interest are small (e.g. ISAs in the old days when the annual limit was <£5k ; or regular saver accounts which only take a minimum per month and have a limited lifespan; or on current accounts with an arbitrary low limit on how much they will pay interest on). So the HTB ISA fits that model perfectly: very low monthly amounts combined with a limited lifespan (the latter because you will probably buy a house within the first few years, as the main incentive - government bonus - will cap out and not grow indefinitely).

2) Banks are more willing to offer high rates where there is a clear cross-selling opportunity from bringing in a new customer who might be susceptible to taking another product linked to the account he has. E.g. preferential rates on current accounts to grab customer who might then buy credit cards, loans, mortgage or other savings products etc. Again the HTB ISA fits that model perfectly: customer does not really care which bank he uses for the product, because same govt bonus is available from all providers, so customer will be disloyal and prone to move if the terms are good; and customer definitely wants a mortgage in the next few years (which might be worth £thousands a year in interest if you land him).

3) We also see that banks typically offer higher rates on accounts which run for a fixed longer term rather than pure instant access, as they can deploy the money received in better opportunities. With the HTB ISA the term is not fixed (you can pull out money tomorrow if you're ready to complete so in that sense it is instant access). However, accountholders are incentivised to keep the money in longer due to the growing government bonus, and in practice they will deposit the money for a lot longer than a month before wanting to draw on it. The bonus disincentivises them from drawing out money on an ad-hoc basis, until they're ready to cash it all in at house purchase time. So banks can use statistical models to project a date when the 'average' person will cash in the account, and not treat it as a pure instant access account. That allows them to pay more interest as they have more certainty on keeping the funds.

So with all (1) and (2) and (3) in favour of banks offering higher interest rates for HTB ISAs than 'normal' accounts, it's entirely expected that rates would be decent. The main big name brands which offer mortgages (Halifax, Nationwide, Santander, HSBC, Nat West, Virgin, Barclays) are all offering at least 8x bank base rate (i.e. 2%), Barclays at 9x; while a smattering of more 'local' building societies are willing to pay even more to get in on the act, some offering 2.5-3% which is at least ten times the current base rates.

In terms of absolute interest paid out though, if you're only putting in £1k plus <£200 pm, the amounts they pay you are not going to 'break the bank'.

Hibernator

Thanks for that detailed reply Bowlhead. On that basis, with a bit of lateral thinking, I'm going to suggest to Sainsbury's Bank a variation to their Saveback Facility, which would be mutually beneficial for Sainsburys as well as most shoppers (because everyone buys food, but not everyone is a first time buyer, or wants [another] credit card or mortgage!):

Loyalty Matchsave Variable Flexible Cash ISA (with a consistently decent rate because it satisfies rules 1-3, and is of course tax-free). Save an amount <= the amount you are spending on your shopping transaction in-store or online. Withdrawls allowed without penalty if used to pay for your shopping, or ISA transfer-out at an anniversary of account opening date.

Saveback currently doesn't apply to their Cash ISA account, nor does it have the tight cross-selling link I am proposing (they currently let you pay in £9000 in one transaction, unrelated to the amount spent on shopping).