The offset mortgage has always been something of an enigma in the UK after being heralded on their first appearance as the future of mortgages, however they have not taken off here in the same way they did in Australia for example.
Part of the reason initially lay behind the fact that advisers and lenders struggled to explain the concept to borrowers who struggled to understand how they worked.
In reality, offsets are a relatively simple concept. A standard mortgage is taken out for say, £300,000 and a savings account, or multiple accounts, are taken out with the same provider. The borrower then deposits their savings into this account which is then “linked” to the mortgage account. Every month the lender calculates the interest you need to pay based on the total amount borrowed on the mortgage less the amount held in the savings account.
In other words, if the borrower has a £300,000 loan, but also has £100,000 in the savings account, the interest is only calculated on the difference between the two, in this case £200,000.
This means that less interest is being paid and therefore either the monthly payments are reduced, or the capital balance is paid of quicker.
With savings interest rates being poor at present, utilizing spare capital to cut down your mortgage payments, or repay your mortgage more quickly seems a much more beneficial use of money. After all, if you have a sizeable amount of cash on deposit struggling to earn 1% in interest, offsetting against a mortgage you are paying 2% or 3% on is a better use of that capital.
In other words, the “effective” return on that capital is much more than the standard savings interest rate. Also, as there is in effect no interest being physically received on the savings then there is no tax to pay on that interest. Hence this is of more interest to higher rate tax payers.
If used in the correct way an offset mortgage really can make a tremendous difference. Not only is the sum held on deposit offset against the loan amount so the interest or the term of the mortgage is reduced, but the amounts paid in remain liquid, (you can take out the savings whenever you wish, it is your money not the lenders), and are not limited in their protection to just the Government guaranteed level.
Another interesting benefit is that parents can use their own savings to assist in bringing their children’s’ mortgage payments down, but still have access to money.
In general, the clients who benefit most from this type of product are therefore those with access to a decent sized savings pot, high net worth individuals who may receive large bonus payments or those self-employed clients with variable income streams.
However, those who are willing to use their offset account as a current account can also experience some good interest savings. With most of these products now charging interest on a daily basis, savings are greater at the start of the month when their salary goes in to the account and then diminishes over the month, although savings are still made.
The big change in this product category is in the cost, with lenders now reducing the rate paid on these products to make the differential between “standard” products now negligible.
For example, you can now get 2-year fixed Offset Mortgages from a mere 1.19%, (3.36% APRC) with whilst 5-year fixes start from 1.75%, (3.02% APRC) fees of £749 and a free valuation and legal fees to boot for remortgages. This pricing is more than compatible with the very best rates out there and better than many.
It is definitely a case of discussing all the options available with a professional adviser, who will provide a good overview of the options available including offsets, rather than simply skirting over their existence.