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. But this was only part of the issue.
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 relatively 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 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.
This all sounds relatively straightforward, but there were other reasons why offsets have not hit the expected heights.
One issue has always been the slightly higher cost of offsets vs the more standard products, although in recent years, not only has the cost of such products come down much closer to the best non-flexible products, but amongst customers and brokers for that matter, awareness has finally increased to a level where they are much more comfortable discussing such products.
Also, whilst Offset Mortgages undoubtedly have their place, it is perhaps not quite as simple as saying that more clients should be taking them. As part of a full examination of a clients requirements a good broker will always normally explain the benefits of such products; however the reality is that many clients simply do not have the cash in savings accounts to make the product work for them.
In practice, savings of between £10,000 and £30,000 are required per £100,000 of loan amount in order to make offsetting worthwhile given the price differential.
Also, the additional flexibility comes at a cost, and most offset rates are more expensive than, for example, the best 2 year tracker rate and even many fixes, even though as competition gets fiercer these rates are coming down. Many clients are just not prepared to pay the additional costs of such a product.
Other clients do not like the idea of paying their salary into their mortgage account, both from a psychological point of view, (seeing a bank statement saying you are £100,000 overdrawn every month can be disconcerting), and the “all eggs in one basket” issue.
There are many other options available which will give clients both the flexibility they are actually going to make use of plus the more competitive rate, as in some cases clients will be better off just taking the cheapest available rate.
It is definitely a case of discussing all the options available with a professional advisor, who will provide a good overview of the options available including offsets, rather than simply skirting over their existence.
In fact, the biggest barrier to the amount of offset products being taken out lays firmly with the lenders themselves. For a product who many think should be the norm where mortgage loans are concerned, an option automatically offered with every product, the inadequacies of lenders IT systems seems to be the biggest excuse for not having such a product.
You would have thought that this would be more beneficial for lenders to work this out. After all, those with a good offset product are more content to stay with their current lender, it encourages more cash to be held on deposit and may well lead to borrowers being more likely to take out other products with the lender, such as a Cash ISA.
The reality for Offset products, is that until lenders get to grips with these issues and decide that actually an offset mortgage should not attract such a price differential, it is likely that offsets will remain obscured in the shadows for a while yet.