Offset Mortgages – perfect for those with savings

by Michael Challiner

Offset mortgages have shaken up the mortgage market, as by far the biggest innovation in recent years. Just six years ago they didn't really exist, but now the offset mortgage and the other newcomer, the current account mortgage, account for £10 out of every £100 borrowed by homeowners. One of the UK's largest lenders is of the opinion that 25 of existing mortgage holders would be best off with an offset mortgage. You could be in that 25, so we suggest reading this article to find out what you could be missing out on. What is an offset mortgage? The essential idea is that while you are borrowing capital from the mortgage lender, you have savings alongside them. The idea is that you pay interest not on what you have borrowed but on what you have borrowed minus the amount in your savings account(s). For example, if you had an offset mortgage of £80,000 and had £15,000 in a savings account running alongside, you would only pay interest on the loan minus the savings, which makes £65,000. You will not, however, earn any interest on your savings; they will purely exist to offset the debt. So what makes it so special? Here's the thing – thanks to your savings, you pay a lot less interest on your mortgage account. You are not earning any interest on your savings, so you can't be taxed on any interest – which means that, especially if you have substantial savings, you are giving a lot less away to the taxman. So people who typically have to give 40 of the interest their savings earn to the taxman will naturally be particularly attracted to the offset mortgage. Consider the following calculations: assuming that you have a £100,000 mortgage over 25 years, paying a low interest rate of 4.69, with a £20,000 deposit. With a normal mortgage you would pay £85,351 in interest but with an offset mortgage you would pay just £41,998 – the difference between those two figures is £43,353. Even better, you would repay the mortgage five years and eight months early because the monthly repayments are calculated on the full mortgage debt before your savings are taken into account. This means that you would be overpaying each month, resulting in early repayment. In theory, on average a standard rate tax payer would make a saving of £9,538 in tax and a higher rate taxpayer a not to be sniffed at £17,341 in tax. Another great advantage to the offset mortgage is flexibility – you can overpay without penalty, underpay and take payment holidays as long as you have built up enough surplus to cover any deficit. Can this really be as good as it sounds? In the past, mortgage borrowers have had to accept a higher rate of interest in order to have an offset mortgage. The good news for today's borrowers is that the banks and building societies are competing on this growing area, and as a result, offset interest rates are becoming a lot more attractive. The interest rate will still be higher than the average mortgage however, so you need to be absolutely sure that the tax savings are not wiped out by the higher interest charge. It's a complicated calculation best entrusted to a professional mortgage adviser. We recommend that a standard taxpayer needs around £20,000 in savings offset against a £100,000 mortgage to give it an advantage over a traditional mortgage. In the same circumstances, a higher rate taxpayer needs to have about £10,000 to make it worthwhile. (These figures are calculated using a typical 4.69 fixed offset rate, in comparison with a 4.49 tracker mortgage.) Needless to say, these figures will change along with the fluctuation of interest rates and, in all probability, as the offset and traditional mortgage rates become more similar. There are many different types of offset mortgage! It's to be expected that as the mortgage lenders fight for your business, they introduce different ‘carrots' to attract you away from the competition. The offer of a free property valuation or free legal work is the most likely suspect. The banks have the advantage of including your current account in the offset calculation along with your savings, whereas some lenders will allow you to nominate two different savings accounts to be offset. Some will allow you to have an extra borrowing facility with a chequebook to be used at your leisure. There are lots of variations as far as the interest rate is concerned. You could be offered any of the following: a low starting rate fixed for 6 or 12 months; a tracker which is guaranteed to stay below the BoE base rate for 6 months and can only go above after six months; or a tracker which tracks base rate plus a small premium for a set amount of years. The percentage of the house valuation (Loan to value (LTV) ratio) you want to borrow will also have an impact on the interest rate. For example, at the moment one lender is offering 5.6 for people that are borrowing less than 50 of the LTV. The interest rate rises to 6.45 for LTVs of up to 99. The basic concept is simple, but the calculations are extremely difficult, so you'll really need to see an independent mortgage adviser to be sure that the offset mortgage is right for you. If you have savings, and especially if you are paying 40 tax, then it is likely that they will suggest the offset mortgage as the best option for you. *Indicative figures correct as at November 2005

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