The biggest innovation in the mortgage market in recent years, the offset mortgage, is now starting to take a significant share of the market. Now, only six years after they were introduced, the offset and the current account mortgage account for 10% of all borrowed mortgage capital.
According to one of the UK’s largest mortgage lenders, as many as 25% of existing mortgage holders could save money in the long run by choosing an offset mortgage. If you’re one of those possible 25%, then it’s important that you are aware of the facts.
What exactly is an offset mortgage?
Here’s the concept: you borrow capital from the mortgage lender and you also have savings sat in another account. Instead of paying interest on your full loan and earning interest on your savings, you pay interest on the amount you borrowed minus the amount you have saved. For example, if you had £25,000 savings and a mortgage of £110,000, you would only pay interest on the sum total of debt, which would be £85,000. Your savings would not earn any interest on a separate level, they would only be linked to the mortgage.
So what’s the big selling point?
The major advantage to this kind of mortgage, particularly where higher tax payers are concerned, is that you end up paying less interest. This transpires because you are not earning interest on the savings, and as you know, the taxman always takes a fair amount of that interest away from you. If you have significant savings, then you lose a lot to the taxman – but not with the offset mortgage. That’s why this type of mortgage is so well suited to people that have to pay over 40% tax.
These calculations illustrate the potential savings:
£100,000 mortgage – 25 years
Interest rate – 4.69%
Traditional mortgage interest payments – £85,351
Offset mortgage interest payments – £41,998
Saving – £43,353
With the offset mortgage you would also complete the mortgage after just 19 years and 4 months. This is because the monthly repayments are calculated without your savings being included in the equation – therefore you would overpay, and finish paying it off early.
On average, a standard rate tax payer could feasibly save £9,538 in tax and a higher rate taxpayer a considerable £17,341.
There’s also the benefit of flexibility – the offset is a lot more forgiving than the traditional mortgage and you can overpay, underpay and take payment holidays without penalties.
If it’s that great, why isn’t everyone doing it?
Offset mortgages used to have high interest rates, putting many borrowers off at the first hurdle. But as this type of mortgage has started to take off, lenders are offering better and more competitive interest rates.
The interest rate is however, still considerably higher than with the fixed rate mortgage for example, and it’s important that anyone considering an offset mortgage can be sure that the tax savings will cover the higher interest charge. It’s the kind of calculation that can only be accurately provided by a professional mortgage adviser.
As a rule, the standard taxpayer must have savings of £20,000 to put against a £100,000 mortgage to make the offset worthwhile. A higher rate taxpayer would only need £10,000 to justify this type of mortgage. (These calculations were made in reference to an average 4.69% fixed offset rate, and a 4.49% tracker mortgage.) These figures will obviously change with the potential rise and fall of interest rates, and as we project, offset and traditional mortgage rates move closer together.
The many variations on the offset mortgage
Mortgage lenders, in their bid to win your business, offer different incentives that they hope will give them the competitive edge. The most common incentive is a free property valuation or free legal work. The banks have a head start as they can include your current account in the offset calculation as well as your savings, but other lenders will let you offset two different savings accounts. Others will offer a borrowing facility and a chequebook.
The interest rate also varies considerably – from a 6-12 month fixed rate, to a tracker guaranteed to stay below the base rate for 6 months, or a tracker which tracks the base rate for a set amount of years, but also charges a minimal premium.
The amount you are borrowing compared to the value of the property will also affect the interest rate. At the moment one lender will give an interest rate of 5.6% for people that are borrowing less than 50% of the property value, whereas anything above that (up to 99%) will have an interest rate of 6.45%.
The concept may be easy for you to get your head around, but the sums won’t be. See an independent mortgage adviser for individual advice tailored to your circumstances, it’s the only way to be sure that the offset is best for you. However, we think that if you have savings and pay interest at a higher rate, you’ll be onto a winner with the offset.
*Indicative figures correct as at 11/05