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Offset Mortgages. A dream for well off homeowners.
Offset mortgages represent one of the biggest mortgage
innovations seen in recent years. Six years ago there was hardly
an offset mortgage to be seen. Now they and the current account
mortgage, to which they are closely related, account for £10 out
of every £100 of new lending.
What's more, one of the UK 's large lenders believes that 25%
of existing mortgage holders would be better off with an offset
mortgage. So if you're in the market for a mortgage you need to
know what they're all about. Otherwise you could be missing out.
Firstly, how does an offset mortgage work?
The basic idea is that besides borrowing money from the
mortgage lender, you also run savings or deposit accounts with
them. Then you are charged interest not simply on what you have
borrowed but on what you have borrowed less the balance in your
savings and deposit accounts. So, if you had an offset mortgage
of £100,000 and had £20,000 in their savings account you
would only be charged interest on the difference, £80,000. In
these circumstances, no interest is paid on your savings - the
interest is offset.
It doesn't sound like a ground breaking idea - where's the
benefit?
Quite simple. Whilst the full benefit of your savings is
reflected in a lower interest charge on your mortgage account,
legally you have not received any interest. If you have not
received interest you can't be charged tax on the interest. Step
away Mr Taxman!
This means that offset mortgages are especially attractive for
higher rate taxpayers who would otherwise pay-away 40% of the
interest they receive in tax.
Consider some figures. If you had a £100,000 mortgage paying a
competitive rate of 4.69% plus £20,000 on deposit, how would the
figures work out? Well over a typical 25 year mortgage, without
offset you would pay £85,351 in interest but with offset you
would pay just £41,998 - that's a saving of £43,353. What's more
you would repay the mortgage five years and eight months early.
That's because the monthly repayments are based on the full
mortgage debt before offsetting is taken into account so
borrowers are effectively overpaying their debt each month.
And doesn't Mr Taxman look sorry! In theory, a standard tax
payer saved £9,538 in tax and a higher rate taxpayer a whopping
£17,341 in tax.
Flexibility can also be a major advantage. You can typically
pay off capital without penalty, underpay and take payment
holidays so long as you've made sufficient overpayments
throughout the years.
Too good to be true - where's the catch?
Historically borrowers have had to pay a higher interest rate
for the benefit of an offset mortgage. But the good news is that
with banks and building societies fighting for a bigger share of
the offset market, offset interest rates are falling.
This means that you need to look carefully to ensure that the
apparent tax savings you could make are not eliminated by the
slightly higher interest charge. Quite honestly this is not an
easy calculation so it's best left to your professional mortgage
adviser.
But as a guide, a standard taxpayer needs around £20,000 in
savings behind a £100,000 mortgage to make the offset deal
better value than a traditional mortgage. For a higher rate
taxpayer the savings requirement drops to around £10,000. (These
figures are based on a typical 4.69% fixed offset rate, compared
with a typical 4.49% rate for a tracker.) These figures will
change as interest rates vary and, in all probability, as the
cost differential between an offset and a traditional mortgage
closes.
Not all Offset Mortgages are the same!
As you would expect, with the offset lenders fighting for your
business lots have added bell and whistles to the basic concept.
Free property valuations and free legal work are relatively
common. Then some banks will include your current account in the
offset calculation, some lenders enable two nominated savings
accounts to be offset, some will even agree an additional
borrowing facility with a cheque book that can be used at any
time.
On the interest rate front you're bound to be offered a low
starting rate fixed for six or twelve months. You might also be
offered a tracker which is below the Bank of England base rate
for six months and which only rises above after six months or a
tracker which exactly tracks base rate plus a tiny premium for a
few years. There are lots of variations.
The interest rate can also depend on what percentage of the
house valuation you want to borrow. For example, one lender is
currently offering 5.6% if you are borrowing less than 50%
rising to 6.45% for up to 99%.
Like so many things, whilst the basic concept is simple, it then
gets complicated! This clearly underlines the need to talk
things through with an independent mortgage adviser. It's their
job to ensure you get the right type of mortgage and the best
deal.
If you have savings, there's a big chance they'll recommend an
offset mortgage.
*Indicative figures correct as at November 2005
About the author:
Michael Challiner has 15 years experience in financial services
marketing at senior level.
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