Is an offset mortgage the answer to your debt dilemma?
Clearing what you owe while trying to save is tricky, but maybe your home loan can help
Sunday 09 October 2011
David Cameron wants us all to pay off our credit-card debt, but for homeowners covering monthly mortgage repayments and trying to save for a rainy day, this is far easier said than done.
Trying to clear debt and build a savings pot is always tricky, but could offset mortgages be the answer?
The principle behind an offset mortgage is straightforward – you set your savings against your mortgage debt. By taking out a mortgage and a linked savings account, instead of earning interest on your savings you offset them against your debt and pay interest only on the remaining balance. So, on a £150,000 mortgage at 4 per cent with £20,000 savings, you would only be charged interest on £130,000 of your mortgage balance which, over the year, could save you up to £800 in interest.
When savings rates are low, offset mortgages come into their own because you can often save far more than you would ever earn in interest. And, you don't pay tax on any interest saved as you would with most savings accounts.
"With interest rates remaining at historic lows, people have looked at different ways in which to make their savings, large or small, work as hard as possible," says Andy Gray, Barclays' head of mortgages. "The flexibility to cut the cost of a mortgage but retain easy access to cash savings is a great combination, and, at the same time, the effective return on savings will generally outweigh deposit rates, especially after tax."
Any money being saved can be used to clear other debt or to top up the offset savings which will lead to even bigger savings on your monthly mortgage repayments. Because repayments on a mortgage are paying both interest and the actual debt, if you can reduce the amount of interest, more of your monthly repayments are clearing the loan and you can pay off the mortgage more quickly.
Offset mortgages are not only beneficial to those with impressive savings pots. Even a modest sum can make a noticeable difference, and an offset mortgage could be the ideal place to start building your nest egg while savings rates are so poor for instant-access accounts. Better rates may be available from fixed savings accounts, but these levy charges if you want early access to your money.
When you take the tax savings into account, offset mortgages look even more attractive. Because you aren't paying tax on the money saved by reducing your mortgage interest, you can effectively boost the interest rate of an offset mortgage by either 20 per cent or 40 per cent for higher rate taxpayers when comparing them with a taxable savings account.
If you have a house worth £300,000 with a £250,000 mortgage, assuming you pay 5 per cent interest, that means £12,500 to the lender every year. If you also had £50,000 in a savings account earning 3 per cent annual interest you would earn £1,500 every year, but after tax this would fall to £1,200 (if you are a basic-rate taxpayer) and £900 (for high-rate taxpayers). If you were to offset that £50,000 instead, you would pay interest only on £200,000, bringing the sum payable to the lender down to £10,000 for the year.
"This results in an annual saving of £1,300 if you are a basic-rate taxpayer, or £1,600 if you pay 40 per cent tax," says Kusal Ariyawansa, of independent financial adviser (IFA) Appleton Gerrard Wealth Management.
Offset mortgages have a reputation for being too restrictive, but if anything they are more flexible than traditional mortgages – as most allow for unlimited overpayments. Plus, you can simply withdraw your savings when you want – but you will then lose the benefit of offsetting that money against your mortgage. And this can cause problems: "It can be oh so tempting to take money out to spend on a nice holiday," says Mr Ariyawansa.
More importantly, you must always check the numbers add up, as offset mortgages tend to have higher interest rates. For those who can access the very best rates on traditional mortgages it will be a matter of calculating whether they will really be better off with an offset facility.
Scott Gallacher from IFA Rowley Turton uses the example of HSBC's Lifetime Tracker at 2.49 per cent and Abbey's offset Lifetime Tracker at 2.95 per cent. The extra 0.46 per cent payable on the mortgage balance is worth £460 on a £100,000 mortgage.
"The initial rate of the HSBC tracker is so low that to offset this, basic-rate taxpayers would need to earn only 3.11 per cent. The Nationwide MySave Online Plus account paying 3.12 per cent would be sufficient," he says. Higher-rate taxpayers would need 4.15 per cent, however, which no instant-access accounts can match.
Bear in mind that the gap between rates on standard mortgages and offset mortgages is closing, however, and there are many lenders who charge only a small premium, while others, such as Clydesdale, don't charge a different rate at all.
"If you can get one that doesn't charge a premium then it's a bit of a no-brainer – if you have got a premium to pay you've got to work out if you're going to use the offset facility enough," says Ray Boulger from mortgage broker John Charcol.
An independent mortgage adviser will be able to tell you whether an offset mortgage is the right option for you.
Ray Boulger, John Charcol
"The people that offset mortgages make the most sense for are higher-rate taxpayers, but it also depends how volatile your cash flow is. An offset facility gives you access to your savings, so if you have a volatile cash flow, whether you receive annual bonuses or you're self-employed and saving up money for tax, you're going to benefit more."
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