All your nest-eggs in one basket

Rising interest rates mean an offset may not be a smart option
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The Independent Online

Offset mortgages have been available for 10 years, yet they still only account for 7 per cent of loans.

Offsets operate by allowing buyers to set their bank account balances against their mortgage. This reduces the total cost of the loan because the home owner only pays interest on the difference between the total debt and their cash.

The effect can be dramatic. Yorkshire Bank calculates that someone with a mortgage of £150,000 and £16,000 in savings will pay it back in 21 years not 25, saving £72,000 in interest.

Some people see offsetting as a way to cut the cost of a large home loan. Barclayshas launched a "City" mortgage that allows bankers and others who get regular bonuses to use them to cut their interest bills.

With interest rates on the rise, however, offsets are starting to look expensive. Most are variable rate loans, tied to the Bank of England base rate. But buyers with savings should not dismiss offset mortgages out of hand, according to mortgage advisers. Interest rates may be higher, but this means the interest a homeowner saves through an offset loan is higher, too.

Should I pay a premium for an offset mortgage?

As with all financial products, it is only worth paying a premium for features you will actually use.

The most common reason for opting for an offset mortgage - or for the "flexible" mortgages offered by some lenders - is to pay back the mortgage early. But owners can often do this more cheaply by making overpayments. "It is a classic example where a borrower does not necessarily need a fully flexible product as many deals now allow a certain level of overpayment without any charge," says David Hollingworth, director at mortgage brokers London & Country. "This is typically as much as 10 per cent a year, which is often more than adequate."

Flexible mortgages do have other advantages, principally the ability to borrow back overpayments or to take payment holidays. With a full offset mortgage this is simply a question of withdrawing the cash from the linked savings or current account. Plus there is the added advantage of saving interest on any cash savings.

Offset mortgages have become more appealing as their cost has come closer to that of a standard, tracker loan.

"If you have to pay a premium of 1 per cent for an offset mortgage you need to have substantial savings to justify it," says Chris Keane, senior product manager for Woolwich and Barclays mortgages. "With the premium down to 0.3 or 0.4 per cent you need fewer savings to make it worthwhile."

How much do I need to save to make it worthwhile?

When offset mortgages first came to the market, they only really worked for home owners with substantial savings. Now that offset mortgages are more competitively priced, the level of savings has come down.

As a rough guide, anyone with around 10 per cent or more of their mortgage advance in cash (bank and building society accounts but not ISAs or investments) could find an offset mortgage worthwhile. "You no longer need £50,000 in savings to benefit," says Keane.

To make the maximum use of the offset facility, however, homeowners do need to move their cash to the bank that they are borrowing from. Some lenders are more flexible than others: Yorkshire Bank, for example, allows homeowners to link up to 18 accounts to the mortgage, so that they can keep their various savings separate.

Nor does it matter whether the bank offering the offset mortgage has a competitive savings rate.

Many high-street banks come in for regular criticism for their poor interest rates on current and savings accounts. With an offset mortgage, however, this does not matter. The borrower earns no interest on their savings. Instead, they save interest on their mortgage debt.

This also brings tax advantages. Higher-rate tax payers are especially well placed to benefit from offset mortgages because, outside of an ISA, they will have to pay tax at 40 per cent on interest in their savings. With an offset mortgage, there is no tax to pay, as you "earn" no interest.

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