How offset mortgages can save you thousands
The devastation caused by the credit crunch has made most people more savvy when it comes to money, with more of us aware of the importance of getting a decent interest rate on savings.
Cash ISAs also fail to beat inflation with top rates of around 3%. This means that for most of us, while on paper it may look like our savings are growing, when we come to withdraw our cash it will buy less than it did when we put it in the account.
Is there any way around this?
Yes. Well, there is if you've got a mortgage. And the magical solution's name? An offset mortgage.
In a low-interest-rate environment, it's not easy to make money from your savings. But an offset mortgage might be the solution. It works by using savings to reduce the interest payable on your mortgage, thereby cutting the total amount you repay the lender.
So, if your mortgage debt is £200,000 and you have £30,000 in an account linked to your mortgage then you'll only be charged interest on £170,000 of the mortgage.
Make your savings work harder
While savings rates are so paltry, an increasing number of people are turning to offset mortgages in order to make their money work for them.
According to First Direct, over the past two years UK offset mortgage borrowers have earned £1.4 billion more on their savings than those who placed their money in best-buy savings accounts.
Offset mortgages can be linked to your current or savings accounts. Multiple accounts can be linked, but they all have to be with the bank you have your mortgage with.
Because they are effectively mopping up some of your mortgage debt, interest is not payable on offset mortgage-linked accounts - which means you don't have to declare them on your tax return. But, importantly, your savings are still accessible.
"In these uncertain times, more of us feel comfortable with a savings cushion," says Melanie Bien, director at brokerage Private Finance. "People want to reduce their mortgage but also need to keep some savings back in case of emergency. This makes perfect sense and an offset gives the benefits of overpaying on your mortgage while retaining access to your savings."
The more you have in savings, the more you will benefit from an offset mortgage. "In an ideal world, you would have as much in savings as you owe on your mortgage, meaning you wouldn't pay interest, but could still draw on your savings," says Bien.
But while a larger savings balance will be more beneficial than a smaller one, Andy Gray, head of mortgages at Barclays, says even if you only have a small amount of savings, an offset mortgage can still work well. "A big misconception is that offset mortgages suit only a certain type of client," he says.
"These days, it's become a mainstream product which has evolved due to changing customer needs and low base rates. The product's value is in its flexibility, which reflects people's changing lifestyles and life stages.
"Consumers who benefit the most from an offset are those who have high balances moving through their current account and also have savings. But our research suggests that a customer may only need 5% of their mortgage balance in savings to achieve material benefits."
But to get the most out of the product, offset mortgage-holders need to be disciplined and run all their money through the offset accounts.
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.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.