Should I save in an ISA or an offset mortgage?

Published by on 04 November 2010.
Last updated on 05 November 2010

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.


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