The offset mortgage, the biggest change to the mortgage market in the past few years, is now starting to get a big share of the market. Now, only six years after they were first made available, the offset mortgage and the current account mortgage make up 10% of all mortgage loans.
One of the biggest mortgage lenders in the UK says that up to 25% of people who already have a mortgage could save money in the long run if they chose an offset mortgage. If you're one of those possible 25%, it's important that you know what's going on.
What does an offset mortgage mean?
Here's how it works: you borrow money from your mortgage lender and have savings in a separate account. Instead of paying interest on your whole loan and earning interest on your savings, you pay interest on the amount you borrowed minus the amount you have saved. For instance, if you had GBP25,000 in savings and a GBP110,000 mortgage, you would only pay interest on the total amount you owed, which would be GBP85,000. Your savings would not earn interest on their own; they would only be linked to the mortgage.
So what makes it such a good deal?
The biggest benefit of this type of mortgage, especially for people with higher incomes, is that you end up paying less interest. This happens because your savings aren't making you any interest, and as you know, the tax man always takes a fair amount of your interest. If you have a lot of savings, you lose a lot to the tax man. With an offset mortgage, you don't lose as much to the tax man. This type of mortgage is great for people who have to pay more than 40% in taxes.
These numbers show how much money could be saved:
Mortgage for £100,000 for 25 years
Interest rate - 4.69 percent
GBP20,000 deposit
Interest payments on a traditional mortgage are GBP85,351.
Offset mortgage interest payments - GBP41,998
Saving - GBP43,353
With an offset mortgage, the loan would be paid off in 19 years and 4 months. This is because the monthly payments are calculated without taking your savings into account. If you overpaid, you would finish paying off the loan early.
On average, a person who pays taxes at the standard rate could save GBP9,538 and a person who pays taxes at the higher rate could save a significant GBP17,341.
There is also the benefit of flexibility. The offset is a lot more forgiving than a traditional mortgage, and you can overpay, underpay, or skip payments without being penalised.
Why doesn't everyone do it if it's so great?
In the past, the interest rates on offset mortgages were very high, which turned off a lot of potential borrowers right away. But now that this type of mortgage is becoming more popular, lenders are offering better interest rates that are more competitive.
Still, the interest rate is much higher than with a fixed-rate mortgage, for example, and anyone who is thinking about getting an offset mortgage needs to be sure that the tax savings will make up for the higher interest charge. It's the kind of math that can only be done correctly by a licenced mortgage adviser.
For the offset to be worth it for the average taxpayer, he or she must have savings of at least GBP20,000 to put against a GBP100,000 mortgage. For this type of mortgage to make sense, a high-rate taxpayer would only need GBP10,000. (These numbers were based on an average fixed offset rate of 4.69 percent and a tracker rate of 4.49 percent.) These numbers will change based on whether or not interest rates go up or down, and as we make predictions, the rates for offset mortgages and traditional mortgages move closer together.
There are many different kinds of offset mortgages.
In order to get your business, mortgage lenders offer different perks that they hope will give them an edge over other lenders. A free property valuation or free legal work is the most common incentive. Banks have an advantage because they can include both your current account and your savings in the offset calculation. Other lenders, however, will let you offset two different savings accounts. Others will let you borrow money and give you a chequebook.
The interest rate also varies a lot. You can get a fixed rate for 6–12 months, a tracker that guarantees to stay below the base rate for 6 months, or a tracker that follows the base rate for a set number of years but charges a small premium.
The interest rate will also depend on how much you are borrowing and how much the property is worth. At the moment, one lender has an interest rate of 5.6% for people who are borrowing less than 50% of the property's value. For anything above that, up to 99.9%, the interest rate is 6.45%.
You may understand the idea well, but you won't be able to do the math. Seek advice from a mortgage expert who is not part of your mortgage company. This is the only way to be sure that the offset is best for you. But we think the offset will work in your favour if you have savings and pay a higher rate of interest on them.
Suggestive numbers are correct as of November 2005