Is mortgage offsetting the way to beat the rates blues?
Stuck with a high-rate home loan and savings that are accruing little interest? This is an alternative. By Chiara Cavaglieri and Julian Knight
Sunday 12 April 2009
A succession of Bank of England base rate cuts has fundamentally altered the personal finance landscape. It may now be possible for some lucky souls to pay virtually nothing in mortgage interest rates, but for others the effects of the Bank's emergent resuscitation of the economy is less clear cut.
Some unfortunates may be customers of one of the laggard banks or building societies which have not lowered mortgage rates in line with the Bank's moves. Worse still, the mortgage borrower may also be a saver and have seen their rates cut to the bone. Plenty of people have lost rather than won from the Bank's desperate attempts to refloat the UK economy.
What do you do if you find yourself in this position? The obvious answer is to remortgage away from your provider or, if you're a savings loser, shift to one of the few remaining banks or building societies paying anything like a decent rate. Another alternative to scouring the savings and mortgage best buys is to switch to what is called an offset mortgage.
Put simply, an offset mortgage allows borrowers to balance their savings against their debt and thus reduce their interest payments. Some lenders, such as Intelligent Finance and Woolwich, will also allow money in a current account to be used. As an example, a standard offset mortgage of £200,000 with a savings pot of £50,000 will be charged interest on only £150,000. This means that the borrower can pay the loan back much sooner by keeping the monthly payments based on the full balance of the mortgage. Interest is calculated daily, meaning that your money is always working to reduce your payments, and as long as your mortgage rate is higher than your savings rate after tax you will benefit financially.
"Customers can put their savings into an offset-linked savings account which allows them, in effect, to overpay on their mortgage and save thousands in interest as well as shave years off the term of their mortgage, while still having the peace of mind that they can access their money immediately should times get harder," says Maria Harris from Intelligent Finance.
Previously, many people were hesitant to give up the chance to earn interest on their savings, but with current savings rates of 3 per cent replacing those long-gone ones of 7 per cent, there appears to be very little to sacrifice and much to gain through offsetting. The offset facility has the potential to allow more money to be saved in interest than could otherwise be gained in a savings account. Even better news is that an offset mortgage is tax efficient as any reduced interest as a result of the savings linked to the mortgage will be completely tax free, unlike a conventional savings account which attracts income tax.
"After all, why keep a sum of money in an account paying minuscule rates of interest when the effect of having it set against a mortgage could be around 4-5 per cent net in crude terms," says Andrew Montlake from mortgage brokers Coreco.
The major benefit to offset mortgage deals, particularly in such financially turbulent times, is that most offer a great deal of flexibility and borrowers can usually overpay, underpay and take payment holidays with relative ease. Most lenders will allow overpayments of about 10 per cent each year, but this is money that cannot be retrieved at a later date without remortgaging, whereas in an offset mortgage, borrowers who put any surplus cash into their linked savings can have instant access to that money while still being able to balance the total against the debt.
This flexibility can really come into its own for those with an erratic income. "If you've got a volatile cash flow, then an offset mortgage works really well," says Ray Boulger, a senior technical manager at mortgage adviser John Charcol. Self-employed people, for example, or buy-to-let investors with irregular incomes, can take advantage of the flexibility by using money put aside for tax to reduce their mortgage but still have access to it when they need it.
Although the flexible features of an offset mortgage are attractive, they must be used properly to be truly cost effective, and only borrowers with fairly substantial savings are in a strong position to use an offset facility to its full advantage. Additionally, offset mortgages have historically cost much more for borrowers than standard mortgages, and with only a relatively small number of offset deals on offer they have struggled to contend with the best buys.
Recently, offset rates have improved, but borrowers are still likely to need to pay a small premium. "At present, clients still pay about about 0.5 per cent more for a full offset product and many of these are on a tracker basis rather than fixed," says Mr Montlake.
Despite this, there are still highly competitive rates to be found and arrangement fees are generally in keeping with those of other mortgages. First Direct, for example, offers a competitive rate of 2.99 per cent, fixed for two years, with fees of £898. Variable rate offset mortgages are faring well with more best-buy contenders than the fixed rate deals, such as the 2.75 per cent deal from Allied Irish Bank (GB) which is currently the second best variable rate deal on the market.
Offset mortgages may also have significant benefits for anyone wishing to borrow extra money. Additional borrowing with your mortgage lender can be tricky, particularly with credit conditions tightening, but those with an offset mortgage, who use surplus cash to bulk up their linked savings account rather than to pay off the mortgage itself, can simply take any extra money they need directly from their savings pot when they choose without incurring penalties.
This is not only easier but also much cheaper because although the monthly interest rate will increase once the savings have been reduced, as Mr Boulger explains, in effect, "you are borrowing money at your mortgage rate".
One of the biggest potential drawbacks to offsetting is the temptation to keep withdrawing funds from savings and therefore lose the benefits. Some homeowners may also prefer to use their savings to gather a larger deposit and opt for the cheapest mortgage rate possible instead. "It may well make more sense, provided you don't need access to your money, to put down a bigger deposit which will attract the best rates," says Mr Boulger.
It is important to seek independent financial advice to calculate whether or not an offset mortgage will equate to bigger savings in the long run.
Flexible friend: Offset helps with home renovation
Elaine McKenzie, 45, from Edinburgh, was unimpressed when she tried to pay off £70,000 from her mortgage. "My lender wanted to charge a penalty for paying such a large amount. That's when I hit upon offsetting." Elaine chose an Intelligent Finance tracker offset mortgage in September 2007, a smart play as interest rates have since fallen on the loan to just 0.4 per cent. "I'm delighted with the rate, but what I really like is the flexibility. I was able to put the £70,000 in a savings account linked to the mortgage, reducing the interest I paid on the £380,000 home loan. What's more, I always had access to my cash."
Some of the cash has been used by Elaine and her partner to renovate their four-bed home. "Work always costs more than you first think, and retaining access to the savings has helped."
Elaine, who works in financial services, is keen to continue offsetting. "In a low-savings-rate environment, it makes sense to maximise your return and that is making the mortgage less expensive."
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