The smarter way to repay your mortgage
Low interest rates are great news for mortgages but, if you're a saver, you're probably wondering whether you'll ever see your money grow significantly again.
One way to make your money work harder is to combine your savings with your mortgage by using an offset mortgage.
With these, any eligible savings you have are used to reduce the size of your debt without having to give up access.
For example, if you have an offset mortgage of £150,000 and £20,000 of savings, you would only pay interest on £130,000.
"Rather than earning interest on your savings, you save interest on your mortgage," explains Chris Keane, head of mortgage products for Barclays's mortgage arm, Woolwich Mortgages.
"Depending on the offset product you choose, this enables you to reduce the size of your repayments and the term of your mortgage."
For instance, in the above example, if you had a Woolwich offset mortgage at 2.89%, £20,000 of savings would see you repaying your mortgage two years and two months earlier than if you'd had a straightforward repayment mortgage with the same interest rate.
This shortened term would also save you £6,029.03 in mortgage interest.
Alternatively, if you decided to stick with the 25-year term, the £20,000 savings balance would reduce your repayments by an average of £45.90 a month. As well as trimming your mortgage, an offset arrangement can also reduce your tax liability.
"You have to receive interest on your savings to pay tax on it; with an offset this doesn't happen," says Paul Stephens, product manager at First Direct.
So, in the above example, if you were a basic-rate taxpayer and decided to stick with the full 25-year term, you would save £2,349.76 in tax if you have received savings interest at 2%.
It's not only your savings that can be offset against your mortgage debt. Some offset mortgages also allow you to offset your cash individual savings account and current account against your mortgage if you hold them with the lender.
"On many offsets interest is calculated daily so, even if your balance drops as soon as your salary goes in, it will still help to reduce your mortgage," adds Stephens.
Flexibility of offset
Offset mortgages also provide additional flexibility, with some allowing you to take payment holidays, withdraw any overpayments or reduce your monthly repayments, as well as make overpayments, either directly into the mortgage or by topping up your savings.
Among those who could benefit from an offset are borrowers with variable income streams, such as the self-employed; people earning commission; young families where income is reduced for maternity leave; people with other business interests; and those with savings, whether these are for being held for long-term plans or for more short-term spending such as a holiday or a new car.
Offsets aren't right for everyone, however. The interest rate, for example, can be higher than conventional mortgages.
Kevin Bray, insight analyst at Defaqto, explains: "You need to understand how to use your money. You're paying more for an offset, so it's important you use the additional features."
Also, some people could be better off sticking with a more conventional mortgage with a savings account alongside.
Ray Boulger, senior technical manager at John Charcol, says: "You can get higher interest rates on ISAs than on the cheapest offsets. And if your partner is a non-taxpayer, you can use their allowance to access better savings rates tax-free."
But if you don't want to chase interest rates or tie your money up for the long term in order to access higher savings rates, then offsets provide the opportunity to make your money work harder for you.
A “traditional” mortgage, where the monthly repayments entail of repaying the capital amount borrowed as well as the accrued interest, so that during the loan period the capital debt is gradually paid off so by the end of the term the mortgage has been fully repaid. One advantage of a repayment mortgage is that it removes the risk of having a parallel investment (such as an endowment policy or pension), the performance of which is dependent on the stockmarket, such as with an interest-only mortgage.
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.