Make the most of a low inflationary world

Despite the widespread doom and gloom about the economy and unemployment figures rising, new research shows that many of us should actually be feeling better off.

The base rate is so low at the moment and with many household bills also falling this means that the average household has seen disposable incomes rise by around 25% over the last year. According to research by Ernst & Young, those lucky enough to have kept their job during the recession will now have an average of £1,075.22 left over each month which is £200 higher than in 2008.

The same research shows that on average, homeowners are paying 20% less on their mortgage repayments than in 2008 if they are on tracker mortgages or have moved onto their lenders standard variable rate (SVR). Contractors with fixed rate mortgages are unlikely to have seen the same drop in their repayments; however you may be saving in other areas.

Household expenses such as energy, petrol and food costs have fallen by just under 8% in the last 12 months according to Ernst & Young which will have given your disposable income a boost. However, whilst this is great news for the average household we cant get too carried away. The cost of other bills such as council tax, public transport and some insurance products have risen in the last year and falling house prices may mean that your biggest asset, your house, has fallen in value.

What should I do with the extra money?

1. Pay off any debts

It's easy to accumulate credit card debt and personal loans when you are purchasing because debt enables you to spread the cost over a period of time. However, having large borrowings hanging over you can be stressful, especially if you have a spell between contracts, especially given that unemployment insurance is virtually useless for Contract workers.

There are various perks to paying by credit card and cards often offer incentives to spend. However, it is wise to try and pay off the balance each month in order to stop yourself from paying interest at what will still inevitably be a stubbornly high rate. If you have an outstanding balance on your cards then using your new disposable income to clear some of it off each month will not only be a weight off your mind, it will also help to save you money in interest.

If you don't want to pay off your debts using your extra disposable income then you could try shopping around for a better deal on the debt that you do have. Switching your existing credit card to a provider that is offering a 0% interest period could save you a substantial amount of money over the course of a year. However, make sure that you won't have to pay a redemption penalty to your current provider if you pay off the balance early. Some personal loans will incur a penalty charge if you repay the balance before the term is up.

Similarly you need to be aware of handling fees that can sometimes take the fun out of an initial interest free deal.

2. Start saving

Having savings equivalent to three months earnings would offer you peace of mind in case you are in between contracts or if anything should happen. If you were to become ill for example then a savings pot would help bridge the gap before your income protection policy kicks in (indeed by asking for a waiting period before a policy needs to be paying out can significantly reduce the premiums you pay). Without money worries you can concentrate on getting over your accident or illness.

An ISA offers an excellent opportunity for you to save on tax whilst putting your extra disposable income away for a rainy day. These tax free savings accounts allow you to save up to £7,200 each year. You can invest in stocks and shares or you have the option to put up to £3,600 in a cash ISA. If you are over 55 then you can now pay up to £10,200 into an ISA and up to £5,100 into a cash ISA (this will apply to everyone from April 2010). The fact that you can often access your money instantly makes these savings accounts very attractive as you know you can get hold of your money when you need it most but often will benefit from far higher interest rates than can be secured on an ordinary account.

Once you have built up your emergency savings pot, you might want to look at other options for saving your extra disposable income each month. A regular savings plan might be a good way to save your left over cash as you can set up a direct debit from your current account and this is a far less painful way to build up a nest egg than relying on you being disciplined enough to manually pay over a cheque into an investment account.

Buying into a stock market based investment could result in a double whammy - you build a financial safety net but could also be buying at seriously depressed prices with substantial potential for upside.

3. Pay more off your mortgage

You may have seen your mortgage repayments fall due to the low base rate, perhaps because you are now on your lenders SVR or because you hold a tracker mortgage. Check that this is not illusionary because you may still be paying over the odds in relation to the wider market.

If you are paying less you could be enjoying the opportunity to pay off outstanding debts, build up your savings or simply to treat yourself.

However, just as a Contractors most valuable asset is likely to your house, for most it is also your biggest financial commitment. If you were to use this money to pay off a larger chunk of your mortgage debt then you could make a substantial difference to your disposable income in the future. Not only would you decrease your overall debt and therefore next months interest payment, you would also help to minimise the effects that falling house prices may be having on your homes value.

With mortgage lenders increasingly reserving their best rates for low 'loan to value' clients. Paying more off the value of your mortgage now may mean you find it easier to remortgage in the future.

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