Find a better home for your savings
Does a return of more than 4% tax-free on your savings sound attractive? If you, or one of your nearest and dearest, have an outstanding home loan, this is effectively the rate you could be earning on your savings by converting to an offset mortgage.
If you are a top-rate taxpayer it is equivalent to earning more than 7% gross on your savings. It also makes it one of the few ways to beat the current inflation rate of 5.1% as measured by the Retail Prices Index.
What is an offset mortgage?
First launched in the UK 10 years ago, offset mortgages work by linking loans with money held in savings accounts and/or current accounts.
The cash in a savings or current account is set against the outstanding mortgage, so the borrower only has to pay interest on the net balance.
If the mortgage were, say, £100,000 and there were savings of, say, £20,000, the mortgage interest would only be charged on £80,000.
Normally, mortgage repayments are still calculated on the full loan, so the borrower ends up repaying the mortgage quicker, thereby saving interest, although some lenders allow lower monthly payments to be made.
Why are they a good idea?
There are two key attractions of offset mortgages, Ray Boulger, technical director at mortgage advisers John Charcol explains.
"First, a higher rate of interest is normally paid on a mortgage than would be received on savings, so using savings to reduce the mortgage balance improves the borrower's net position.
"Second, interest received on savings would normally be subject to income tax, but because no interest is actually received, the offset arrangement is very tax-efficient, particularly for higher-rate taxpayers.
"This tax treatment means any savings in an offset account effectively produces a return at the mortgage rate grossed up to the borrower's relevant marginal rate."
What are the disadvantages?
The main disadvantage of offset mortgages is that they can be more expensive than the cheapest conventional mortgage deal, so the cost advantage from the savings offset is negated.
Borrowers should not be misled by offset lenders who quote higher effective savings rates because that can mean their mortgage rate is less competitive.
However, in recent years the premium charged for offset loans has shrunk. Nowadays, they can even be the cheapest option for certain types of loan.
For whom are they useful?
These mortgages are best for people with adequate levels of savings or fluctuating earnings.
David Hollingworth, head of communications at London & Country Mortgages, says: "Each product is a bit different, but an offset loan should pay if you have the equivalent of around 5% of your mortgage balance in savings.
"Alternatively, if you get a large annual bonus, which you gradually spend, or you are self-employed and have to build up your savings to pay your tax bills twice a year, these sums can be offset against your mortgage in the meantime."
Family offset mortgages are also available for parents who want to help their children up the property ladder, but can't afford to lose control of their savings.
Which lenders offer them?
The Woolwich was the first lender to introduce offset mortgages. Others now in the field include Accord Mortgages, Clydesdale Bank, First Direct, Norwich & Peterborough, Santander and The One Account.
The Newbury and Yorkshire building societies offer family offset mortgages. There are many types of offset mortgages, including fixed rate and tracker loans.
This article was originally published in Money Observer - Moneywise's sister publication - in August 2010
A way of combining a mortgage and savings so the savings “offset” and reduce the mortgage. Rather than earning interest on savings, the savings reduce the mortgage and the interest paid on the borrowing, so savings are effectively earning interest at a higher rate than most mainstream savings accounts will pay. They are also tax-efficient, as savers avoid paying tax on interest that their deposits would otherwise have earned. Offset mortgages offer the disciplined borrower a great deal of flexibility, as overpayments can be made to reduce the term or monthly mortgage repayments, which can save thousands of pounds in interest payments over the mortgage term.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.