Look your biggest debt in the eye

Current account mortgages take years and thousands off your house purchase loan. But you'll need guts and self-discipline

Flexible mortgages, which allow an element of leeway as to when and how your loan is paid off, are all the rage. While they are a good thing on a day-to-day basis because you can overpay or underpay occasionally as circumstances dictate, there is a greater benefit in the long term: you are free to pay off your mortgage early and thereby save a considerable amount of interest.

Flexible mortgages, which allow an element of leeway as to when and how your loan is paid off, are all the rage. While they are a good thing on a day-to-day basis because you can overpay or underpay occasionally as circumstances dictate, there is a greater benefit in the long term: you are free to pay off your mortgage early and thereby save a considerable amount of interest.

You could, however, take early repayment a step further, through a current account mortgage or CAM - also known as an Australian mortgage because they are so popular with the financially astute Down Under. In this country the idea is still relatively new (although the market is growing steadily), with a choice of just two providers - First Active Financial, part of the Irish-based building society First National, and Virgin Direct.

The basic principle of a CAM sounds distinctly alarming to anyone used to running their daily banking requirements from one current account based on being in credit, and keeping mortgage, personal loans and other debts separate. CAMs enable you to roll them all into one single account. The hard part is getting your head around a current account on which you owe your whole mortgage; in effect it feels like a huge and long-standing overdraft, into which your monthly salary disappears in a depressing fashion.

But that is just a state of mind. Used sensibly, a CAM allows you to pay off your debt faster than any conventional flexible mortgage, saving tens of thousands of pounds. You do need to make an imaginative leap in order to get the gist of how it works, though.

How does this "flexibility" work, exactly?

It works on several levels. A key element in current account mortgages (and some conventional flexible ones) is that interest on your debt is calculated daily - so any additional money in the account reduces the debt for as long as it is in there, even if that is only for days.

So an overpayment immediately reduces the debt?

Exactly. But with most flexible mortgages you are also free to underpay or take what is known as a payment holiday if, say, you have a big one-off expense or you won't be earning for a few weeks.

But how are CAMs different from other flexible mortgages?

A true current account mortgage gives you a single bank account, into which your salary (plus any other one-off payments you want to channel that way) is regularly paid. Against that is set your mortgage debt and other loans. All your debt is charged at the same rate of interest, typically around the standard variable mortgage interest rate. That is cheap borrowing compared to personal loan rates.

What about my banking needs?

All your regular banking can be done through the account as normal - you can set up standing orders and direct debits, you'll be given a cheque book and debit card, you can withdraw cash from ATMs. The difference is that your monthly statement shows a large debt instead of the modest credit that most of us hope for.

How on earth does that reduce my mortgage?

Well, because interest is calculated daily, and on your entire salary rather than just a "mortgage" chunk taken out, you're effectively making an overpayment each month. Even if you spent all your earnings in the course of the month, you would still cut your repayment time and costs simply by having them paid into the mortgage account.

Come again?

Virgin Direct gives the example of someone earning £40,000 a year with a 25-year mortgage of £150,000, paying interest at 7.2 per cent. By paying their whole £40,000 salary straight into a Virgin One account, they save £8,560 and complete their repayment seven months early, even though they have completely spent up at the end of each month. If the person manages to save £50 each month (which is left in the account), they can save almost £30,000 in interest and cut the repayment time by three years and three months.

And if they could save more?

The sky's the limit. Someone earning £50,000 with a £120,000 loan from First Active at 7.74 per cent, overpaying £200 each month, could save more than nine years' debt and £64,000 of interest on a 25-year term.

What if I would like to transfer my existing mortgage but it is an endowment mortgage?

No problem: because no monthly repayment is involved, you'll have a slightly lower "interest only" mortgage payment to meet each month - and when your endowment policy matures, simply pay it in as a lump sum. As you will have been reducing the outstanding debt in the intervening time, there is a greater chance the policy will more than cover the balance outstanding.

This overpayment talk is fine, but I might need to borrow a lump sum for a loft conversion...

You can increase your debt by as much as you need, up to the maximum you borrowed in the first place. It is all charged at the same flat interest rate. But you do have to repay within your agreed timeframe, and it must be before you retire.

OK - but how can I save for a rainy day if all my money is going into paying off a debt?

This is a tricky issue to grasp - but you will be better off using any money in a deposit account to reduce the debt (and increasing the debt if you need additional funds at some point) than storing up savings. First, the interest you're paying off is almost bound to be higher than the interest you would be earning; and, second, your money does not attract tax in a mortgage as it would in a deposit account.

Well, I would certainly be happy to switch to a CAM, if I could find one with a decent discount or two-year fixed rate...

Ah, there's the rub. The line taken by Virgin is that CAM holders gain so much in the long term that they must be prepared to pay the standard variable rate (currently around 7.5 per cent) for the privilege. That is feasible if you're not mortgaged up to the hilt, but many people are paying fixed or discounted rates of 1.5-2 per cent less than that, and they don't want to increase monthly payments by £100 or more - especially as mortgage rates are expected to rise further before they plateau.

What about First Active?

They are rather more responsive in this respect. They have a six-month discount of 3.25 per cent on the standard variable rate (which varies from 7.74-8.24 per cent according to the loan to value). Better, though, is a new two-year stepped discount of 1.5 per cent for the first year, reducing to 1 per cent for the second. On a £120,000 mortgage with a 75 per cent loan to value, that amounts to a saving of £2,295 over the two-year period. Interestingly, if that money were treated as an overpayment and left in the account rather than being spent, it would shorten the repayment period by almost two years and reduce total interest payments by £22,100.

Are there any other good CAM deals around?

The trouble is that the market is so young there is nowhere to transfer to at the end of the discount - whereas shrewd conventional mortgage holders can move on to the next attractive discount with another lender, as the existing one ends. But that is likely to change with time.

So whom will CAMs suit best?

CAMs are really designed for relatively young homeowners - in their twenties to forties - who have a reasonable salary now that they expect will rise further. People such as freelancers and commission-based earners - whose income, though comfortable, may be sporadic - can benefit from the payment flexibility. And those with a scattering of debts can bring them together at a single interest rate markedly lower than any personal loan rate. But access to extra funds is instant, so you do need self-discipline. And to look to the long term.

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