A win-win situation for borrowers: Loans linked to your current account or savings are an attractive option
Thursday 10 June 2010
Linking your mortgage to your current account or savings could mean cutting the cost of your mortgage. That's especially true at the moment when savings rates are so low. If you offset your savings against your outstanding mortgage, you'll effectively be earning interest at whatever your mortgage rate is. And that's likely to be much higher than you can earn on your savings at present.
"With the base rate at 0.5 per cent, savings rates are low, so now is a good time for many homeowners with savings to consider offsetting," says Nick Scarrett, head of pensions and investments at Fair Investment Company. "At the moment, many people will be paying more interest on their mortgage than they are earning on their savings, and this doesn't make financial sense."
Offset mortgages link the balance of your mortgage to the cash you hold in savings or current accounts. It lets you "offset" the credit balance in your other accounts against the mortgage balance, so interest is only paid on the difference.
The effective rate of return you get on your savings is the mortgage rate you're being charged, and there is no tax to pay, so the return will often be much better than that currently available on a savings account. For example, a basic-rate taxpayer offsetting against a mortgage charged at 3.5 per cent would need to earn 4.38 per cent gross on a standard savings account to get the same effective return. A higher-rate taxpayer would need to earn a gross savings rate of 5.83 per cent.
David Black, banking specialist at the analysts Defaqto, says: "Offset mortgages can work extremely well for higher-rate taxpayers who have a mortgage and savings. Offset mortgages effectively offer tax-free interest on savings at the same rate as the mortgage."
He calculates that a savings pot of £20,000 would, at the average offset mortgage rate of 4.25 per cent, knock £850 off the annual mortgage interest on a mortgage higher than £20,000. To earn that amount on a taxable savings account, a higher-rate taxpayer would need to find a savings account paying a gross interest rate of 7.08 per cent.
Black says: "Others who could benefit from an offset mortgage include the self-employed, buy-to-let landlords, anyone who receives a fairly substantial part of their income in the form of an annual bonus or even those paying school fees. In these instances, an offset mortgage can provide the borrower with the flexibility required to assist with irregular income streams or outgoings."
John Hughes of the Britannia agrees. "Offset mortgages are a good option for people who earn bonuses or get paid by commission as they might be able to pay a big deposit on their savings or current account every so often, offsetting their mortgage even more. Offset mortgages vary from lender to lender, but as a rule they are quite flexible, offering the opportunity to overpay, underpay, pay in lump sums and even repay your mortgage early. If you are running low on cash, you can even take a payment holiday."
Such flexibility can make an offset look very attractive, but borrowers should look at the small print of deals to ensure they can use the mortgage the way they need, warns Black. "There are some significant differences in the features offered by the 160 different offset mortgages, so consumers should think about what features are important to them when doing their research."
Paul Kaye, general manager of sales at the Leeds Building Society says flexibility is one reason why more borrowers are beginning to choose offset mortgages. "Because savings are kept in a completely separate account, there is no need for a fundamental reorganisation of finances, and customers have unlimited access to them at any time, providing great flexibility and peace of mind."
And flexibility is becoming increasingly important to homeowners, according to research published in May by Lloyds TSB. Some 68 per cent of mortgage borrowers said flexibility is important, and 40 per cent said it was "very important". Stephen Noakes, head of mortgages at Lloyds TSB, says: "Our research shows that customers want to have a greater degree of control over how much they pay, and have the opportunity to flex payments dependent on economic conditions."
Offset mortgages are often seen as being more expensive than standard deals. The headline low fixed or tracker rates borrowers may be offered with a non-offset mortgage are often not made available to those who choose an offset deal. That shouldn't stop borrowers considering them, says adviser Drew Wotherspoon of John Charcol. "Generally, for borrowers with good levels of savings, offsets present a viable option, especially when obtaining anything more than a token return on a savings account is a labour of herculean proportions.
"The premium you have to pay for an offset varies from lender to lender, so if you can find one that doesn't load the rate for the privilege then it makes sense to have the option even if you do not use it to a great level. The general rule of thumb is that if you use an offset correctly you can save money on your mortgage, which will also help you pay it back quicker. Yet borrowers should seek specific advice about whether an offset is the best solution for them."
Using savings to offset against a mortgage rather than using the cash to make overpayments can make sense, according to David Hollingworth of brokers London & Country. "One of the benefits of offsetting rather than overpaying is that you retain easy access to the savings in case they are needed. That means that funds earmarked for other purposes like a tax bill or a holiday can be put to good use until they're required."
He says offsetting savings can offer a win-win situation, as borrowers look to take advantage of the low base rate and eat into their mortgage, and savers become disillusioned with the rates on offer and seek a better return. "In addition, offsetting and maintaining the monthly payment at the usual level means there is a slight overpayment each month, and the mortgage is therefore eroded more quickly. With concerns over rates rising in the future, reducing the capital balance now should be easier and help ease some of the pain for when rates do lift."
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