Is Offsetting Your Mortgage The Answer?
Offset mortgages are in the news again -- we look at their pros and cons.
What should you do if you're given a large bonus from work that you don't want to spend now, but still want easy access to in the future? Stash it carefully away? Or how about use it to reduce the interest payable on your mortgage?
Although offset mortgages have been around for quite a while now, they're still considered by many to be quite a new concept. Essentially like a flexible mortgage, you additionally have a savings account linked to your mortgage account - but instead of earning interest on your savings your money is used to "reduce" the balance of your mortgage. So if you had a £100,000 mortgage with £10,000 in the savings account, you would only accrue interest on the £90,000 portion. The smaller your debt, the more quickly you can pay it off, meaning that many people are shaving years off their mortgage term and a fortune in interest.
Putting this into a simple example, £10,000 in an account paying 5% AER would earn £500 in gross interest over a year - £400 for a lower rate taxpayer and £300 for a higher rate. Over 10 years a lower rate taxpayer would make £4,802 and a higher rate £3,439.
At the same time, a £100,000, 10-year interest-only mortgage at 6% would cost you £60,000 in interest. By using that £10,000 to offset the loan (and effectively make it £90,000) you would only suffer £54,000 in interest, saving £6,000 in interest.
So although a higher rate taxpayer would have sacrificed £3,349 in interest on his savings, he would have saved nearly twice that on his mortgage! (Of course, he would need to leave his £10,000 untouched in the account for ten years, but many people would admit to saving large sums of cash for many years).
Clearly there are savings to be made and careful use could result in homeowners shaving thousands of pounds and years off their mortgage term. So why don't more people have them?
Well, one major factor has been the interest rates. Until recently, offset mortgage rates have tended to be less than competitive, making them relatively unattractive. However, in recent months rates have been falling with some available at less than 5%, making them a far more attractive option than before. Additionally, many providers now include an offset option with their traditional repayment mortgages.
You need to ensure you've done your sums carefully. The idea of savings helping to offset mortgage debt sounds fantastic - with savings rates being so low at the moment savings aren't earning a fortune and this way you could prevent your cash from being effectively taxed again.
Current Account Mortgages
Whilst the offset mortgage uses just your savings to work against your mortgage debt, Current Account Mortgages (CAMs) although similar, work by having everything in one account: mortgage, savings, borrowings, salary, any other income etc. You then simply use this account as your current account. So every pound you pay in starts working against your borrowings straight away.
What's more, as you can transfer other borrowings to the account too, any expensive loans/credit card balances can be repaid at the same rate as your mortgage, which is usually a cheap way to borrow. Many current account mortgages also provide a loan facility, should you need to borrow more money in the future.
However, an important drawback to the current account mortgage is the fact that it is often only one account. Instead of being able to see your savings (albeit earning no interest) and mortgage separately, logging into your account can reveal what looks like a very scary overdraft - which can be very depressing! Luckily, some lenders have cottoned on to this problem, so you should be able to find a CAM that allows you to at least view your money and borrowings as separate accounts. And it's worth remembering that although CAMs are great if you have a lot of debt (as you can roll it all up at one relatively low rate) they are rarely the cheapest mortgages. And again, to make a real difference you need to leave a lot of money untouched in the account for many years.
Who benefits most?
Offset mortgages can be particularly good for people who are self-employed, or receive hefty annual bonuses. By putting money that's been set aside for tax purposes into an offset savings account, self-employed homeowners can benefit from their cash working against their mortgage debt. And paying in annual bonuses can make a substantial difference.
However, it's worth remembering that to make a real difference, the money must be left alone for as long as possible. Of course, most of us don't have large sums of money just kicking around. However, all good Fools should have a decent sized rainy day fun (a fund containing between three and twelve months income, to be used in an emergency). By saving this into an offset savings account you could benefit from reducing your mortgage, whilst still being able to access the cash quickly, should you need it. Some offset mortgages even allow you to include what's held in mini cash ISAs.
So if you're considering whether or not to choose an Offset/CAM, remember:
- This type of mortgage is particularly good for those with large sums of cash on deposit. To really benefit, one guideline is to have around £10,000 in savings for every £100,000 mortgage debt, although smaller amounts can make a difference.
- CAMs can prove very good options for homeowners with other, expensive borrowings (credit cards/loans etc).
- You must be financially disciplined, especially if considering a CAM. There is the potential to access a lot of cash, which could prove irresistible to many. If in doubt, pick a traditional repayment mortgage.
- Check the rates carefully. A more expensive offset or CAM can cost you more in the long run than a cheaper, typical repayment deal.
- Many providers, such as Standard Life, allow customers to add the offset option to their discounted products
Remember, you may already have an offset option with your current mortgage, so it's worth checking your details or contacting your lender. Offset and CAMs are a great idea, particularly if you have a large sum of money that you wish to maintain access to. However, if you can afford it, you can achieve a similar effect by overpaying.
So if you're about to take out a mortgage, or re-mortgage the deal you have, consider offset and current account mortgages, you could save a fortune.
> Compare mortgages of all descriptions here at the Fool.