Should I save in an ISA or an offset mortgage?
Q: Am I better off leaving my savings inside my offset mortgage, on the basis that they don't attract tax and will help me pay off the mortgage earlier? Or should I move some money into an individual savings account that earns more interest?
My mortgage rate is 1.05% at the moment, so £80,000 is earning £80 monthly, but the cash ISA is earning 3.2% with £7,200 in each (there is one for myself and one for my husband).
Also, are my savings still guaranteed if the bank goes bust? I presume the money would be used to repay my mortgage first.
Richard Morea is technical manager at mortgage brokers London & Country
A: Generally speaking, offsetting cash against a mortgage gives an impressive return on savings. As interest is only charged on the net borrowing, the savings are effectively earning the mortgage rate and there's no tax to pay.
This means that a basic-rate taxpayer with a mortgage at 4% would have to earn 5% gross on a standard savings account to get the same return as offsetting. This figure would rise to 6.67% for a higher-rate taxpayer.
However, some borrowers are obviously benefiting from incredibly low rates that were taken out before the credit crunch hit, and it certainly sounds like this is true in your case.
As there is no tax to pay on a cash ISA, it's a case of looking at whether you can get a better rate on the ISA than on the mortgage.
See best cash ISA rates here.
As your figures illustrate, that is possible, and so you will outstrip the return on offsetting by putting the cash in an ISA. Just remember that ISA limits have increased and the maximum that can be placed in a cash ISA is now £5,100 each.
The Financial Services Compensation Scheme says currently 'set off' can be applied by an administrator where someone has borrowed and deposited savings with the same institution. So in the event of the bank collapsing, the administrator can set the savings against the borrowing and so protect the savings - but this might potentially mean remortgaging to free up the cash once more.
The five-second guide to offset mortgages
ONE: An offset mortgage allows someone to offset their savings against their mortgage held with the same bank, so that interest is only paid on the difference between the two. This means more of your mortgage goes to pay off the capital, so you clear your debt more quickly and pay less interest overall.
TWO: Your lender won't pay interest on your savings, but as a result you don't pay tax.
THREE: Offset mortgages tend to have slightly higher interest rates than standard mortgages, so you need some savings to offset in order to keep interest payments down.
FOUR: Offsets are popular with people earning variable amounts such as self-employed or commission-based workers.
FIVE: They are very flexible, allowing mortgage holders to take payment holidays or make over-payments or underpayments, depending on their circumstances.
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.
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.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.