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AER - Annual Equivalent Rate
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Escalator Bonds


Are characterised by an interest rate that increases in steps over the life of the Bond. In most cases the gross interest rate will increase from the first year to the second, from the second to the third and so on. In other cases the rate of interest can increase from month to month....

If you see such an escalator bond offering 1% for the first year and 3% for the third, is it worth buying? How much is it worth to you?

Naturally one tends to focus on the higher rate payable at the end which sounds attractive. The low first year rate however may at first appear unattractive.

In order to compare bonds it is a good idea to compare the AER quoted for the account with that offered by other escalator, or other flat rate accounts.

There are a number of reasons that a bank or building society might offer an escalator bond, or escalator account. They may:

* take a view that interest rates will increase during the life of the bond

* wish to encourage saver loyalty by offering higher rates in future

* wish to publicise a high headline interest rate while incurring minimum short term costs

What's in it for the saver?

* the saver may share the view that rates will rise and be prepared to commit to a longer term if the rate reflects that view

* the saver may disagree, expecting rates to fall, and wish to benefit from what they perceive as an error made by the Bank or Building Society. After 2009 some escalator Bonds, offering up to around 5% in later years, proved a good buy for savers!

* the escalating rate may be combined with the ability to withdraw early, so were the rate to rise faster than the bank or building society thought, the saver can correct their mistake by accepting a penalty for early withdrawal

* later, higher, rates may often appear to offer attractive income for later years. However the saver should recognise that this may well reflect lower interest paid earlier on.

Savers do need to beware of steeply rising short term escalator accounts. One such recently offered a seemingly attractive headline 3.5% for months 9-12 of the year, but only 0.5% for the first month and less than the prevailing instant access rate for the first 5 months.
In this case, if you needed your money back early, the rate was not as good as many instant access accounts, and if it was left for the year the AER proved to be lower than some 1 year accounts. However the saver was left with the option of early withdrawal which would be of value to some.




 

 

 
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