Is an offset mortgage right for you?
Q: I've been reading up on offset mortgages and to be honest they seem too good to be true. What are the drawbacks of such a mortgage? I found one with First Direct with a fixed-interest rate at 3.99%, which is not too bad. Also, say I took out a £100,000 mortgage, what is the maximum amount of savings I can offset it against?
A: Richard Morea is technical manager at London and Country
Offset mortgages have grown in popularity since their introduction in the 1990s and are now an established option within the mortgage market.
With an offset mortgage, the lender charges interest on the difference between the mortgage balance and any savings held with the lender.
This means that a borrower with a £150,000 mortgage and £30,000 in savings will only be charged interest on £120,000 of their mortgage.
The trade off is that the lender does not pay interest on the savings, but considering tax is due on interest paid on savings accounts (unless you have an individual savings account), the rate saved on the mortgage account, can often be greater than the net return that could be achieved on any savings.
Lenders generally allow the borrower to offset up to 100% of the mortgage costs, which essentially provides interest-free borrowing.
Where the interest is reduced through offsetting, the borrower usually continues to make the full monthly repayment, which reduces the capital balance.
When considering an offset mortgage, the key is to not be swayed by features such as unlimited overpayments, underpayments and payment holidays, especially if it's unlikely you will use them.
Any mortgage should be compared on the key elements such as the interest rate and any fees, remembering to include traditional mortgages that may be more suitable.
Offset mortgages can come with higher interest rates than might be available for traditional mortgages, so the borrower has to be certain they will benefit from an offset deal if they are to pay a premium.
However, the margins have reduced and in some cases offset deals have market leading rates, especially on lifetime trackers where they are most common.
Some lenders allow the borrower to also offset their current account, so it may be worth considering switching your banking, especially as you are considering a deal with First Direct.
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 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.