Your flexible friend
Paying off your mortgage early probably seems like nothing more than a daydream, reserved for those prepared to forgo shopping trips, regular nights out and holidays in the sun for the rest of their young lives. However, with a wide range of flexible mortgages now on offer from many lenders, an end to your home loan could be closer than you think.
Offset and current account mortgages (CAMs) allow you to link up your finances, making it easier to keep track of your money. By offsetting your home loan with your savings and/or current account, you only pay interest on your mortgage balance minus the amount of money you have in credit. So any money in your savings and/or current account will reduce the amount you pay in interest on your mortgage.
“The great thing is that borrowers can benefit immediately from money saved in their offset reserve,” adds Ashley Ramsey, marketing manager at Standard Life Bank, a provider of offset mortgages. “Interest on the mortgage is calculated daily on the net balance, so the offset benefit grows on a daily basis.”
This flexibility can then enable you to pay off your mortgage early, take payment breaks, or underpay if you need to. Ramsey continues: “Offset mortgages are the ultimate flexible product. They give you the freedom to shorten the length of your mortgage term or reduce how much you pay each month. In addition, the extra money held in the account is not tied in and you can still have easy, direct access. This allows you to manage your money effectively, knowing that it’s working hard at all times.”
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Savings sense
In a low-interest-rate environment such as we have now, standard savings accounts typically offer relatively low interest rates. However, the interest rate charged on your mortgage will probably be higher, meaning it could pay to forgo a lower typical savings rate and place your extra funds in an offset account instead in order to reduce the amount of interest paid over the course of your mortgage term.
David McIntosh, spokesman for offset lender Intelligent Finance (IF), explains: “A higher-rate taxpayer would normally see 40 per cent of any interest on their savings accounts swallowed up by tax. But because they receive no interest on any savings linked to an offset mortgage, there is no tax to pay.”
He calculates that to get the same benefits available from offsetting, a higher-rate taxpayer with an offset mortgage would need to find an equivalent savings rate paying almost 12 per cent. A standard-rate taxpayer would need a rate of nearly 9 per cent to match the benefits of offsetting. McIntosh adds: “That savings account would need to have no tie-ins or penalties before it could match the benefits of offsetting – I suspect accounts like this are few and far between.”
Offset mortgages are traditionally associated with self-employed borrowers, those who receive regular bonuses or those with a lot of savings. However, as the flexible mortgage market develops, more people are considering this option. McIntosh says: “Historically, offset deals were only seen as a viable option for people with large amounts of savings, but as rates become more comparable with standard deals, they have become suitable for more people – for example anyone who keeps a healthy cash balance, self-employed people, professionals who get lump-sum bonuses and those with commission-based or irregular income.”
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Standard Life Bank’s Ramsey adds: “Offsetting is a flexible solution, so it suits all types of homeowners – those with lump-sum savings and those who wish to put money aside on a monthly basis. However, the more you can put in up front the sooner you start seeing the benefits.”
Simon Chalk, mortgage planner at Mortgage Portfolio Services, recently crunched some figures on offsets for a higher-rate taxpaying client and found he would need to have roughly £1 in savings for every £4 of debt in order to make offsetting worthwhile. In other words, you would need roughly £25,000 to make an offset worthwhile with a £100,000 mortgage. Otherwise, a high-interest savings account and a standard mortgage might be more beneficial.
From a more general perspective, recent research carried out by IF showed households with savings worth 8 per cent of their mortgage balance could be better off with an offset mortgage.
Products available
A very basic offset product will offer a mortgage linked to savings alone. However, some mortgage lenders go further by offering borrowers access to cash ISAs and current accounts (such as IF), or will even allow you to add other borrowings to the mix, such as loans or credit cards.
The One Account’s CAM comes with a current account, but doesn’t prevent borrowers from having an additional current account elsewhere. Other loans and credit cards can also be linked at the borrower’s discretion. Jane Reynolds at The One Account says: “A CAM works like a conventional current account where a chequebook and a debit card are provided. Standing orders and direct debits can be set up and managed through the account.
“The borrowers’ salary is normally paid into the CAM and, along with any savings, will reduce the balance and therefore the amount of interest charged – though customers have instant access to withdraw the savings/salary back out again as and when they want to.”
One area of confusion among borrowers is often the difference between offset mortgages and CAMs. They work on the same general principles. A CAM obviously includes a current account link-up along with that for savings, but so do some offset products, such as the IF range, so what’s the difference? Well, while an offset product will hold your savings separately from your mortgage – combining them only for the daily interest calculation – with a CAM your funds are all kept together in the one pot.
Taking a payment break with a CAM is also easy, according to Reynolds. “As long as it doesn’t take the account balance above the agreed balance limit, you don’t need to give any notice of your intention to underpay or take a payment holiday,” she explains.
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Comparing rates
A big advantage of offsetting is having the ability to borrow back, or redraw, some of the funds you have already paid into your mortgage. However, Chalk advises double-checking the redraw rate before choosing an offset product if you intend to take advantage of this facility. He says some lenders only allow you to borrow back at their standard variable rate, rather than the initial deal rate.
Chalk adds: “As well as this, a number of lenders offer interest rates for the savings account different from that for the mortgage. You need to check that the rate is the same for both elements, otherwise you could have a little bit of interest to pay on your savings.”
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Don’t be surprised if the interest rates on offsets and CAMs are slightly higher than those for standard mortgages. This may not always be the case, but it is to be expected when you factor in the extra flexibility that this sort of product offers. It’s simply a matter of weighing up what’s more important – the best rate on offer or a higher degree of flexibility.
Ramsey of Standard Life Bank sums up the typical offset borrower as financially shrewd, viewing offset as a long-term benefit, rather than a short-term gain. “The advantage of offsetting is that borrowers potentially have the freedom to shorten their mortgage term or reduce monthly payments without moving lender, so they can avoid the hassle and expense of constantly remortgaging.”
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Date: 5th, June, 2007
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