Could your savings help pay off your mortgage?
Conventional wisdom says that you should put any spare money into a savings account. Yet if you’ve already set aside a chunk of cash for a rainy day and you have a mortgage, it may be time to consider an offsetting arrangement to make your savings work harder for you.
Offsetting works by combining your savings account, and depending on the product, perhaps also your current account or individual savings accounts with your mortgage.
It works like this: any savings that you have are deducted from the amount you owe on your home loan and interest is charged only on the difference. This means if you have a mortgage of £200,000 and £15,000 in a linked savings account, you would only pay interest on the net balance of £185,000.
So while you won’t earn any interest on your savings, you pay less interest on your mortgage and shorten its term. And, because you aren’t earning any interest, you don’t have to pay on your savings.
Louise Cuming, head of mortgage services at Moneysupermarket.com says this makes these arrangements particularly tempting for higher-rate taxpayers who see 40% of their interest lost to tax when they hold money in traditional savings accounts.
"Ordinary savings accounts can become a real headache for people in the higher rate band as they are only taxed at basic rate at source," she explains. "They can become an administrative burden, but with offset mortgages you can save on interest and reduce this hassle."
"The offset concept is also totally flexible, so you can pay off lump sums, underpay and take a break from repayments if needed" adds Andrew Montlake of broker Cobalt Capital.
A higher-rate taxpayer with a £150,000 mortgage over a 25-year term and just £5,000 in savings could save £7,817 more through offsetting this compared to interest they would earn on a savings account.
The more money you have to offset against your mortgage, the bigger the benefits. If, for example, the same person had £30,000 in savings, they could save a staggering £41,259 over the life of the mortgage and shave eight years and six months off its term.
The types of borrowers who may wish to consider offsetting vary considerably. The facility is ideal for those who have a lump sum, such as an inheritance or bonus, that they would like to pay into their mortgage, but at the same time don’t want to lose access to it.
"Anyone who has got a decent sum on deposit and wants to make it work harder could consider offsetting this," adds David Hollingworth, spokesperson for broker London & Country. "It works a bit like overpaying on a mortgage, but when you overpay on a standard mortgage it’s hard to get your funds back so you wouldn’t want use all of your rainy day fund in this way. Offsetting does the same job, without you losing access to your money."
Those who receive bumper bonuses, the self-employed who need to aside money for their tax bill, or parents saving for children’s school fees could all make use of offset mortgages.
"We mainly deal with city workers with bonuses or those with large savings," says Montlake. "But as competition has been growing and rates are more attractive, even basic-rate taxpayers with less savings can find that offsetting works well for them.
"People may use their savings as and when they need them - for tax bills, or perhaps to make home improvements, or pay school fees," continues Montlake. "The money might not stay in their account, but while it does it is working hard for them."
Dealing with mortgage shortfalls
There is also a generation of savers with endowment policies who are facing a shortfall on their mortgages - who are using an offsetting arrangement to help whittle down their mortgage debt. "To make offset really work, you’ve got to have disposable income of some kind, and you should be financially savvy and enjoy managing your finances online," says Cuming. "Keeping your liquid funds offset for as long as possible will improve the savings."
So how much savings do you really need to make offsetting work? As a starting point, London & Country Mortgages recommends having around 10% of your mortgage in savings for offsetting to make sense, making these products by no means limited to the super-wealthy.
“However, the margin between standard deals and offset products is being squeezed, seeing even basic-rate taxpayers with smaller savings pots benefiting," says Hollingworth. "It is a product for a wider audience these days, and could even become an expected feature on standard mortgages in the future."
Offset mortgages first appeared on the market in 1997, and as they’ve matured in recent years - with lower rates and a better understanding of how they work - increasing numbers of homeowners are trying them out.
With £1 in every £10 borrowed for UK mortgages going into an offsets, today’s rates can be as cheap as some standard fixed rate and tracker mortgages.
The growth in the number of providers - five-fold over the past decade - has driven innovation, and there are now more than 250 offset products on the market offering more tailored solutions to suit a variety of borrower needs and budgets.
"There is a wider selection with fixes and trackers, either over two-years or the life of the loan," says Hollingworth. "And the difference between standard and offset deals has been crunched down with increasing competition."
Fixed rates give the security of stable monthly payments, while trackers are subject to movements in the Bank of England’s base rate.
"Also, borrowers have easy access to their money in an offset deal," says Hollingworth. "Savings accounts with higher rates will often only allow restricted access to your cash."
Some lenders, such as Woolwich, Intelligent Finance, and Norwich & Peterborough building society allow borrowers to link a current account to the mortgage debt as well as savings accounts.
Cuming says: "Lenders are beginning to appreciate that there is a lot more built in loyalty with offset customers, as they are less likely to consider remortgaging with linked accounts and lifetime deals, so it’s worth them pricing competitively."
However, beware of early repayment charges (ERCs), she adds. "These have crept into offsets over the past 18 months, with a typical charge on a two-year product being 2-3%."
Offsets are certainly not suitable for all as they rely on a savings pot to make them worthwhile. Those with little spare cash should look elsewhere - as if you don’t use the features there is the risk you are getting a poor deal.
"Also, psychologically they won’t work for some borrowers," explains Montlake. "Some lenders don’t show savings and mortgage pots separately on paperwork, so it can look like you have a £200,000 overdraft on your account.
"A lot of people find this hard to deal with, as they want to be able to see their savings sum clearly to feel good about it, rather than only a massive debt."
Remember that many standard mortgage deals now include a degree of flexibility. Some allows fixed overpayments of up to 10% a year as standard.
Ultimately, it’s vital to get the right deal for your circumstances, so seek advice from a broker if you’re confused about your options. After all, not everyone is looking for flexibility in a mortgage, and if you don’t think you would use any flexible features, they are not worth paying even a little extra for.
You may be better off opting for a lower-cost deal and choosing one of the many regular high interest accounts on the market for your savings.
Changing mortgages without moving home. Property owners chiefly remortgage to get a better deal but some do so to release equity in their homes or to finance home improvements, the costs of which are added to the new mortgage. Even though you’re not moving house, you still need to engage solicitors, conveyancing and the new lender will require the property to be surveyed and valued.
An overdraft is an agreement with your bank that authorises you to withdraw more funds from your account than you have deposited in it. Many banks charge for this privilege either as a fixed fee or charge interest on the money overdrawn at a special high rate. Some banks charge a fee and interest. And other banks offer a free overdraft but impose very high charges for exceeding the agreed limit of your overdraft.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
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.
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.