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Guide to Banking Basics

Offset mortgages

Since the late 1990s, a new type of mortgage has swept through the UK.

It is called an “offset” mortgage, and experts believe that by 2010 it could well take up to 20% of the UK mortgage market.

How does an offset mortgage work?

Basically, you offset the money you have in your savings account, and sometimes your current account, against your mortgage.

Instead of earning interest on your cash, you pay less interest on your borrowings. For example, if you had a £250,000 mortgage and £20,000 in current and savings accounts, you would pay interest on just £230,000 of your mortgage.

You receive the same rate of interest, or a similar one, in some cases on your savings as you pay on your mortgage, but because you never actually get that interest, you do not pay tax on it.

Avoiding this tax has a dramatic effect on the interest rate you are, in effect, receiving on your savings.

For example, let’s look at Intelligent Finance, which offers its own offset mortgage. Say it charges a variable rate of 6.1% APR.

Offsetting offers the equivalent of 8.54% for a higher-rate taxpayer, because you is not paying 40 per cent tax. A basic-rate taxpayer receives an effective interest rate of 7.44%.

By the way, IF’s account only offsets the first £100,000 of savings at the existing mortgage rate. If you want all of your available funds to be used to offset the mortgage, you should look at the One Account, or First Direct.

One extra feature of many offset mortgages is that because ALL sums of money are lumped together – and because interest calculations on what you owe are worked out daily – the interest charged on your loan actually falls on payday. It then rises slowly throughout the rest of the month until the next payday.

Is there a downside?

Some people argue that offset mortgages are typically far more expensive in terms of the rates of interest charged, than many of the cheaper fixed and discounted deals.

Research in the summer of 2004 by Charcol, a mortgage broker, claimed that to overcome the problem of higher rates, a borrower needs to have savings that are the equivalent of 20% of the total sum borrowed.

The complexities of each borrower’s financial circumstances make it difficult to prove this point beyond all doubt, partly because it also depends on how much income goes into the offset scheme each month.

Another problem is that some offset mortgages – though not all – add both savings and borrowing together and simply provide one statement. This can encourage people not to repay their debt as quickly.

However, most offset mortgage providers now keep the different accounts and debts separate and link them only when calculating interest.

Some lenders have current account mortgages. These are similar to offset mortgages except that they always have a current account attached and usually require that your wages are paid into the account to get the best effect.

Who benefits from offsetting?

• Some brokers claim that you should have at least £10,000 in your savings account before considering offsetting

Otherwise, the inconvenience of keeping your money in the offset account will probably outweigh the amount of interest that you save on your mortgage

Yet many offset mortgage lenders allow very fast access to their borrowers’ money, even if repaid.

• People who are self-employed or paid sporadically in lump sums often benefit from offsetting because they can save money for their annual tax bills in their offset account and not pay any tax on the savings interest while using the growing sum to cut the interest on their mortgage

• Offsets are better for higher-rate taxpayers, who would be paying more tax on their savings

Before you take out an offset mortgage

Look at the interest you pay on your mortgage and receive on your savings. You may be better off with a good discount mortgage and savings in a high- interest account than taking out a mediocre offset deal.

Tip: Remember that the interest on offset mortgages is calculated daily. Therefore, it makes sense to keep as much money in your account as long as possible.

If your mortgage is linked to a current account, change all direct debits and standing orders to the end of the month – or just before your next payday

More pages

Page 1: Introduction
Page 2: 4) What online information should a bank display?
Page 3: Offset mortgages

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