COMMENT
Save A Fortune On Your Mortgage

By Alison Hunt (TMFAlly)
May 18, 2005

The biggest expense each month for most homeowners is their mortgage.  After all, it's the biggest loan many of us are ever likely to take out, and although it's classed as a good loan (as we're buying something of value) it can still be regarded as a bit of a 'millstone' around the neck.

Repayment Mortgage

A typical, 25 year repayment mortgage works by splitting the payment you make each month. Some of it goes towards reducing the loan, whilst some goes towards paying off the interest that has accrued. In the early days, it's mainly interest that is paid.

However, as time goes by, more of your payment goes towards attacking the loan itself – which then reduces faster and faster until it's suddenly all paid off!

And the smaller your loan is to begin with, obviously the more quickly it is paid off.

Savings

In the meantime, as good Fools most of us have rainy day savings set aside. This is between three and twelve month's income that has been saved and set aside as a cash cushion to cover any potential expensive emergencies that may occur (you lose your job, the boiler breaks down, the car suddenly dies etc). Depending on how secure you like to feel this can add up to quite a substantial sum of money.

Unfortunately, when you take tax into account the maximum interest that can be earned on this cash is not that much – even top rate savings accounts paying 5% effectively only give a higher rate tax payer 3%. And saving the maximum £3,000 into a tax-free mini-cash ISA will still only provide around 5% interest.

So in one hand you could have a mortgage charging interest at ca. 6%, and in the other hand savings earning interest at ca. 3% after tax.

But what if you could use your savings to act against your mortgage?

Offsetting Your Mortgage

Offset mortgages work by using your savings to reduce your loan.

For example, if you had a £100,000 mortgage, and £10,000 in savings, by using the savings to offset the mortgage you would effectively reduce the mortgage to £90,000. Now, as your loan is effectively a tenth less, you will pay it off more quickly – meaning you will pay less interest and can pay the loan off earlier.

Don't worry about your savings – they will still be happily sitting in a separate account, ready to be reached quickly in an emergency, but instead of earning 3% interest, they are now saving you 6% interest on that part of your mortgage!

Here's how it works:

On a £100,000, 25 year repayment mortgage at 6% you will pay around £644 each month. So over the full 25 year term you will pay around £93,290 in interest.

On the other hand, £10,000 worth of savings at 5% gross will earn a higher rate tax payer £300 interest each year (after tax) or £10,900 over 25 years.

If you were to use these savings to offset (i.e. reduce) the loan at the same interest rate, the total interest payable would be around £67,000 – thus saving over £26,000 in interest.

What's more, if the payments remained the same you would shave over three years off the mortgage term – meaning the loan would be fully repaid in 22 years, rather than 25!

Current Account Mortgages (CAMs)

Not bad! And you can take this even further. By taking out a Current Account Mortgage (CAM) such as the Virgin One Account, your current account balance could be taken into account as well as your savings – meaning you can save even more interest!

Of course, you would need to check out the interest rates on offer for both Offset and CAMs mortgages carefully – after all, there's no point saving all this money if the interest rate you're paying is much higher than the best buy deals. And those with a flexible loan but unable to re-mortgage can achieve a similar affect by overpaying.

But if you fancy shaving years off your mortgage term and a small fortune in interest, why not check out Offset and CAM mortgages? You may find they can save you an absolute fortune.

You can find out more about Offset and CAM mortgages, and apply for the Virgin One Account through our Mortgage Centre.