Personal finance: Mortgages can be flexible friends

Switching to a flexible mortgage makes a lot of sense, and can cut your repayment period substantially. By Tony Lyons
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The Independent Online
MORTGAGES ARE no longer as tax efficient as they once were. But the new style of flexible mortgage is an exception to this. Not only can it be used to pay off your home loan quicker than a conventional mortgage, it can also be used, especially by higher rate taxpayers, as a means of saving with a keen rate of interest.

All home loans nowadays attract tax relief on some of the interest payments. The current rate of MIRAS, as it is known, is 15 per cent on the interest payments on the first pounds 30,000 of a mortgage. So, for example, a pounds 50,000 interest-only mortgage at 7 per cent would have gross monthly repayments of almost pounds 292. After tax relief, this would reduce to around pounds 265.

This applies to all mortgages. But the flexible mortgage has many advantages over other types of home loans, especially for the self-employed or those who expect regularly to earn large bonuses. They allow the borrower to use lump sums to pay off part of the loan with an immediate reduction in the outstanding capital, unlike most other types of mortgage that only credit one-off payments once a year. They also allow regular overpayments that have the effect of eventually substantially reducing the mortgage term.

Other benefits allow them to be used almost as current accounts. After a while, usually six months or a year depending on the lender, the borrower can take a one or two month mortgage holiday, missing repayments without any penalty. And if overpayment has taken place, it can be re-borrowed later on.

It is use of these overpayments that make flexible mortgages tax-efficient. "Using them as a savings vehicle makes sense when you look at the maths involved," says Roddy Kohn, an independent financial adviser. "Mind you, the benefits will only be appreciated by those with the money to overpay."

To see how it works, let us look at an interest-only flexible mortgage with Alliance & Leicester, one of the cheapest on the market. Since the beginning of the year, it has been on offer at 6.49 per cent if bought over the telephone, or 6.74 per cent if taken out through one of the lender's high street branches.

A pounds 50,000 interest-only loan over 25 years with the Alliance & Leicester would cost a net pounds 328.29 a month. In the first four years, interest payments after MIRAS would amount to pounds 12,226. If over the first four years, the borrower paid pounds 50 a month extra, and put in pounds 2,000 a year lump sum from an annual bonus, this would save pounds 1,181 in interest payments.

Let us now assume that at the beginning of the fifth year, the borrower wants to buy a new car. The overpayments on the mortgage amount to pounds 10,400, enough for either a small car or a very good second-hand one. So instead of raising a loan elsewhere, the borrower uses the overpayment. Assuming payments on the mortgage go back to the original amount, the term of the home loan will have been reduced by 13 months. If repayments continue with pounds 50 a month extra being paid in, the period of the loan will be reduced from 25 years to 19 years and 5 months.

Put another way, by overpaying on the flexible mortgage, you are effectively not only reducing the term of the loan, you are also attracting a good rate of interest on the overpayments. Many people with mortgages save money in deposit accounts. They are lucky if this money now earns 4 per cent before tax. Even the best tax-free TESSAs, where the money has to be saved for five years, only pay around 7 per cent interest free of tax.

By comparison, overpayments on a flexible mortgage are effectively "earning" around 11.2 per cent for higher rate taxpayers, 8.8 per cent if they pay the basic rate. "Debt reduction is always a good thing" says Graham Bates, another independent financial adviser. "Why people do not switch to these new flexible mortgages but instead go on paying interest of 22 per cent on credit card borrowings is a mystery. At the end of the day, savings out of taxed income earn low rates of interest elsewhere. By overpaying for a time on a mortgage and later on withdrawing it as a loan is an efficient use of money."

Flexible mortgages are available from: Alliance & Leicester on 0345 108108; Bank of Scotland on 0645 812812; Clydesdale Bank on 0800 419000; Egg (Prudential) on 0845 6000290; First Active Financial on 0345 743743; Furness BS on 0800 834312; Household Mortgage Corp on 01494 459100; Kleinwort Benson on 0171 475 6600; Legal & General on 0870 0100338; Manchester BS on 0161 833 8884; Market Harborough BS on 01858 463244; Mortgage Express on 0500 050020; Royal Bank of Scotland on 0800 121121; Sainsbury's Bank on 0500 700600; Scottish Widows on 0845 8450829; Standard Life on 0845 8458450; Sun Bank on 01438 744505; The Mortgage Business on 0345 253253; Tipton & Cosely BS on 0800 833853; UCB Home Loans on 0645 401400; Vernon BS on 0161 429 6262; Woolwich on 0845 607 6666; Yorkshire Bank on 0800 202122

The Independent is offering a free 36-page `Guide to Flexible Mortgages', with tips on all aspects of home loans, including how much you can borrow, how to repay, and a list of useful names and telephone numbers. For your free copy, sponsored by First Active, call 0800 550551 or fill in the coupon on this page