what is the maths for ditching fixed and paying penalty?

randm

have a fixed rate cash isa at 2.05% . trying to work out if to go to higher interest isa  and pay the 90 day penalty. So - Is it correct that to work this out i take 90 days as a quarter of a year- so take a quarter off that interest rate which would mean if i could get a rate better than 1.5% then i should pay the penalty and move? I saw martin do the sums on tv but it was a bit quick.thank you.( and yes i have read a lot of the  previous posts first).!
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refluxer

You were doing OK right up until the 1.5%  - the rate you're moving to obviously needs to be a fair amount higher than the one you're moving from, in order to make switching worthwhile

With the best one-year fixes being around 3.8 to 3.9%, it's hard to see how you'd be worse off by switching but if you wanted to crunch the numbers, you could use this simple online interest calculator to give you some exact figures. 

randm

refluxer said:

You were doing OK right up until the 1.5%  - clearly the rate you're moving to needs to be a fair amount higher than the one you're moving from, in order to make switching worthwhile. 

i don't understand, martin said if the 90 days interest was taken off , then it would be as if one was getting 1.5% interest on that money.so to move it and pay the penalty. is that correct ?

refluxer

randm said:

i don't understand, martin said if the 90 days interest was taken off , then it would be as if one was getting 1.5% interest on that money.so to move it and pay the penalty. is that correct ?

I'm not quite sure what he was getting at but, whichever way you look at it, if you move from an account paying 2.05% to an account paying 1.5% then you're going to be worse off and the penalty just exaggerates this.

How close are you to the end of your fix ? If you let us know the date you took it out, the duration of the fix and how much you originally paid in, then I'm sure we can help you to work out whether it's worth switching.

intalex

Please feel free to comment/correct, but I use the following math to evaluate this decision:

A = Current balance (£)

B = Current fixed interest rate (%)

C = Current remaining term (days)

D = Penalty interest for breaking term (days)

E = New fixed interest rate (%)

F = New fixed term (days)

What you lose if you switch:

1. Interest earned for remaining term in current fixed rate account: A*B*C/365

2. Penalty interest: A*B*D/365

Total: X = A*B*(C+D)/365

What you gain if you switch:

Interest earned over current remaining term: Y = A*E*C/365

If Y > X then you are better off paying the penalty in switching PROVIDED you are happy to tie up your money for F-C additional days (or C-F less days) at the new interest rate E

Edit:
Further simplified to: If E/B - 1 > D/C then it's worth taking the hit and switching

Should also factor in A to quantify the benefit (Y-X from above) and F to consider how much longer the money is tied up (F-C days)

Edit2: Even more simplified in words:

A penalty hit and switch is worth it IF:

provided other factors (£ value of difference and additional term) are acceptable.

randm

just to clarify i was not saying that i was moving to an account paying 1.5%.

i can either go to another isa fixed or not, or put into a savings account. i  am a non tax payer.

so, have £70000 in cash isa fixed at 2.05%, matures july 2023. all cash isa's fixed or not, and savings, have higher interest rates than that at the moment.

if i move the money out i lose 90 days interest.

hope that helps.

refluxer

There are a number of ways of working out whether transferring out of a fixed-rate ISA is worth it. FWIW, this is how I do it using the calculator I linked to above and presuming the ISA you took out was fixed for a year...

£70k in one-year fixed rate cash ISA @2.05% taken out on 01/07/22 will be worth £71,435 when it matures on 30/06/23.

If you transferred it today, it would be worth £70,515 minus the 90-day penalty of £354 = £70,161

£70,161 put into a one-year fixed rate cash ISA today @ 3.85% will be worth £71,900 on 30/06/23, making you £465 better off on that particular date than if you'd left the original ISA until maturity.

NB. all workings are approximate, figures rounded off to the nearest £ for simplicity and it's presumed that the new provider will back-date interest to the closure date of the original ISA. Make sure you do your own calculations with the right dates before making a decision.

As to the broader subject of whether your money is best placed in an ISA or normal savings account, if you're a non-tax payer, I would first have a read of MSE's article on Tax-free savings and the starting savings rate if you haven't already.

Expotter

refluxer said:

£70k in one-year fixed rate cash ISA @2.05% taken out on 01/07/22 will be worth £71,435 when it matures on 30/06/23.

If you transferred it today, it would be worth £70,515 minus the 90-day penalty of £354 = £70,161

Following on from this example, you would need an account that pays at least 1435-161= 1274 for the remaining 234 days in order to break even.
So lets call the rate R, 

 70161x R x 234/365 = 1274,  finding the value of R= 1274/ 70161/ (234/365) = 0.0283, which is a rate of 2.83%.

This means that in order to make it worthwhile, you have to get a rate higher than 2.83%. At 3% for example, you would make 1349 in the remaining time, 1349+161=1510 compared with the 1435 you'd make if you leave it at 2.05%. 

savit4l8er

I'm OK with working out whether a change of fix is worthwhile but will just say this thread will be invaluable to many with the examples and reverse calculation above. All good stuff and something to keep handy.  

randm

thanks for all the advice. hopefully one day, someone will put up an online calculator that works the whole thing out.

may i ask, with the post from intalex above,  " A*B*C/365 ", are the * for a b c to be times or plus..

intalex

* = multiply (that's what they use in Microsoft Excel)