Offset mortgages: How to link your savings to your mortgage
By Kate Saines
If you don’t mind sacrificing the return on your savings in order to reduce the interest on your mortgage you could be the ideal candidate for an offset mortgage.
These flexible products might sound like the ideal mortgage solution, but research suggests they are often overlooked and tend to be rebuffed by borrowers who simply do not understand the nuts and bolts of the product.
Luckily there are lenders out there keen to extol the virtues of the product. Here are the facts to help you make your mind up on whether Offset mortgages are the product for you.
Offset mortgages...
...link your mortgage to your savings account, although some lenders allow you to use your current account or even – on occasion - a credit card or unsecured loan.
This is how it works: When you take out the mortgage, you also open a savings account with the lender. Your savings are then used to offset the mortgage, so you only pay interest on the debt not covered by the savings.
For example, if you take out a mortgage for £200,000 and you have £10,000 of savings you will only pay interest on £190,000 of the mortgage.
You can take out tracker, fixed-rate and discounted rate versions of offset mortgages. And they also tend to offer flexible features such as options to make overpayments, underpayments or take payment holidays.
Borrowers benefit from offset mortgages...
...because they are paying interest on a reduced debt. This provides them with the ability to repay a greater amount each month and therefore bring down the balance of the loan more rapidly.
Also, the flexibility of these mortgages means if you earn a bonus or come into some money you can make overpayments and reduce the loan even further.
What’s more, by using your savings, or current account, to offset your mortgage you are sheltering your gains from the tax man.
This is because the money you are earning in interest is offsetting your mortgage. So while you don’t earn any interest on your savings, you are slashing your mortgage payments and paying no tax at the same time.
Chris Smith, group direct mortgage manager at Yorkshire Building Society, said there tended to be many myths surrounding offset mortgages which put people off applying for them.
Research by the building society found 30 per cent of people were not aware offset mortgages existed, one third did not know how they worked and a third did not understand them.
Many thought you needed a lump sum of cash to make an offset work, a large number believed you could not access your savings and that money could only be held in one account.
Mr Smith added: “The reality however is much different – you can hold separate accounts, you only need to invest a small amount to make a difference and you will have instant access to your savings at all times.”
Watch out...
... because you do not earn interest on your savings or current account when you use them to offset your mortgage.
There are great tax advantages to this. But you need to weigh up whether these advantages are valuable enough for you.
Unfortunately, offset mortgages tend to have higher interest rates than traditional home loans. However, you should not necessarily let this put you off, particularly if you have a healthy savings pot.
And, as with all products, there are deals to be had by doing plenty of research and looking into what’s on offer.
Yorkshire Building Society’s research found many people avoided offset mortgages because they feared rates would be too high.
But independent financial research company Defaqto said the difference in rates between mainstream mortgages and offsets was narrowing. What’s more, some lenders no longer charged a premium for offset mortgages.
Chris Smith of Yorkshire added: “As part of our pricing policy at the Yorkshire we only price our offset products 0.1 per cent higher than those of our regular non-offset mortgage range.”
Offset mortgages are ideal for...
...higher rate tax payers. This is because you do not pay tax on your savings or current account – whichever is linked to your mortgage.
In a statement last year, David Black, insight analyst for Defaqto explained a savings pot of £20,000 would, at the average offset mortgage rate of 4.25 per cent, knock £850 off the annual mortgage interest on a loan higher than £20,000.
To earn that amount on a taxable savings account, he explained, a higher rate taxpayer would need to invest in an account paying 7.08 per cent gross.
Offset mortgages also suit people who earn money erratically – for example, the self employed – and those for whom the bulk of their salary is earned through annual bonuses.
These people can take advantage of the offset mortgage’s flexibility and make underpayments or overpayments according to how much they earn each month.
Buy-to-let landlords and parents paying school fees are also likely to benefit from offset mortgages, said Defaqto.
Meanwhile First Direct is promoting its offset mortgage as an ideal way for parents with adult children still living at home to utilise the housekeeping money to their best advantage.
It suggests parents using their children’s board money overpay just £160 per month could save over £10,000 in five years on their mortgage.
Richard Tolchard, senior mortgage product manager at the bank, said: “First Direct’s offset mortgage is the perfect mortgage facility to help parents whilst they’re supporting their offspring. You never know, in these trying times, we could see young adults being asked by their parents to stay home for longer.”
And on the subject of family, there are now lenders offering mortgages which allow family members to put up their savings to offset the mortgage of a first time buyer.
Mortgage broker John Charcol recently flagged up one such product from Newbury Building Society.
Its Family Offset mortgage has an initial rate of 3.95 per cent, which is a 0.5 per cent discount off the building society’s standard variable rate (SVR) for three to five years.
Ray Boulger of John Charcol explained the basis of this mortgage, a 95 per cent loan to value (LTV) product, is that one or two family members must deposit a total of 20 per cent of the purchase price with Newbury.
This reduces the lenders risk to 75 per cent, because it takes charge of the savings.
Mr Boulger added: “This not only gives Newbury the comfort to offer a mortgage at such a high LTV but also allows it to offer a far lower interest rate than would otherwise be necessary for a standalone high LTV mortgage.”
This set-up not only helps the young first time buyers onto the property ladder, but if the family members offering the savings are higher rate tax payers they will also benefit.
When looking for an offset mortgage you should consider...
... the maximum number of accounts you can link to the mortgage. If you are a higher rate tax payer the more accounts the better. Remember, you can also link current accounts to the mortgage.
Check out the early redemption charge (ERC). This is the penalty for ditching the mortgage before the specified time or term of the product ends.
And make sure you know exactly how much you are allowed to overpay without penalty. Most lenders tend to apply conditions to this aspect of their mortgage and often restrict the maximum overpayments allowed to ten per cent per year.
Use the Myfinances.co.uk comparison tables to find the best deal on an offset mortgage
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