Use This Mortgage To Crack The Credit Crunch
Could an offset mortgage put a smile on your face this summer?
This article was first sent to Fools in an email as part of our Summer Lolly campaign.
2008 has been a pretty miserable year up to now, with dreadful summer weather, England's absence in the Euros and, of course, the credit crunch.
The global liquidity problems are now starting to hit home for many, with increased food prices, the rising cost of petrol, and the threat of negative equity looming. While some people are still managing to keep on top of their finances, others are feeling the pinch.
If only there was a mortgage that could adapt to the different times in people's lives -- a product that could offer benefits to those feeling flush, but provide a flexible approach to people who are going through a tough time.
Hang on a minute... What about an offset mortgage? This is the most flexible type of mortgage deal and it comes into its own in challenging times like these.
What is an offset?
An offset is a revolutionary type of mortgage. It links your money in the black with what's in the red. So by keeping your savings in the bank you can reduce your mortgage debt.
For example, let's say you have:
- a £100,000 mortgage that you pay 7% interest on, and
- £10,000 in savings that you earn 4% interest on (and then that interest is taxed).
Instead of paying interest on your £100,000 mortgage debt and earning interest on your savings, an offset mortgage lender will allow you to link them up, so you only pay interest on £90,000.
So you're saving 7% interest on £10,000 of your debt, rather than earning 4% (before tax) on £10,000 of savings. This means you effectively save at the higher rate of the mortgage (7%, instead of 4%). And best of all, you pay no tax because you're not earning any interest. So offsets are particularly beneficial for higher rate taxpayers.
Confused? All you need to know is that, with an offset, you will be charged the best interest rate possible for your whole finances. And this basic principle of offsetting goes further than savings and a mortgage. Some products allow you to roll in other debts, such as loans, and other `savings', such as the money in your current account.
What's the effect?
Because all of your money in credit is `effectively' being paid into your mortgage (although it actually remains in a separate pot) you owe your lender less and are therefore charged less interest on your debt.
Then a very clever thing happens. You start to chip away more and more at your debt, since the interest you have to pay accounts for less of your monthly payment. The cumulative effect of this virtuous circle of `less interest, less debt' can literally save you tens of thousands of pounds
- According to mortgage lender Intelligent Finance if you have a £220,000 25-year repayment mortgage, your monthly repayments would be £1,477 (based on an initial rate of 5.9% and overall cost for comparison of 7%)
- Assume you have £10,000-worth of savings to which you add a monthly sum of £100, plus you have a monthly income of £4,000 going into and coming out of your current account each month.
- By offsetting this money you could save £76,438 in saved interest over the term of your mortgage, which you would also cut by four years and one month.
But what has this got to do with the credit crunch?
You can do a lot of different things with an offset so they suit a lot of financial situations.
If you receive a bonus you can use it to your advantage and offset the sum against your debt, or you can overpay each month when times are good. This does two things -- pays down your debt and gives you a buffer.
Many people are currently concerned about negative equity, for example those who bought recently and borrowed at a very high loan to value, or even took a 100% mortgage. By overpaying in the good months you can pay down your debt and reduce your LTV, which could be important if you want to move to a larger property. Lenders are currently unwilling to lend at high LTVs so it makes sense to reduce yours while you can.
But what if times are not so good?
Well, if you get made redundant, you could have a significant buffer in your offset mortgage if you have been overpaying. This gives you breathing space as offsets are not all about paying more in -- you can have that money back when you need it.
You could take a payment holiday for three months, underpay your mortgage for a while or even take your money out of your savings. Of course your projected term and total costs change each time you move the goalposts -- and there are limits.
Put simply, an offset mortgage gives you options and lets you use your money in the good years as a type of insurance policy against more difficult times. But unlike an insurance policy, if you don't claim on an offset, you don't lose your money; in fact you save even more over the long run.
More: Find out what an offset mortgage could save you using our mortgage calculator
> Compare offset mortgage deals at Fool.co.uk