FOOL'S EYE VIEW
Flexible Mortgages: Your Friend

By David Berger
May 2, 2001

Once upon a time, back in the dark days of the 1970s, a mortgage was seen as a privilege. Building societies did borrowers a favour by lending them the money to buy a home. It's not surprising that in this atmosphere mortgages were constructed to favour the lender strongly and that ideas of "customer service" or "value for money" were tossed out of the boardroom window as being dangerous and revolutionary.

In the 1980s and 1990s the world changed and value for money has swept to the top of the agenda in mortgages, as it has in all things to do with money. Some of the best value mortgages on the market today are flexible mortgages, which surprisingly enough originated in Australia, better known as the home of the late Don Bradman, psychotic reptile man Steve Irwin, and our very own super-hero, TMF Googly.

These mortgages allow a lot more, would you believe, flexibility in the way you manage them. The interest is generally calculated daily, rather than monthly or yearly, which makes them a lot more efficient, and they generally allow you to:

• Overpay
• Underpay
• Deposit lump sums
• Withdraw lump sums
• Pay off the mortgage early
• Take payment holidays
• Have a cheque book / credit card facility
• Receive monthly statements

Looks a lot like a  bank account, doesn't it? That's because in many ways it is and another name for this kind of mortgage is a current account mortgage. By combining all your debt under one roof into what is effectively one massive, huge, gigantic, apparently terrifiying overdraft, these mortgages bring a number of significant benefits. Foremost among these is that all your debt is brought down to the lowest interest rate: that of your mortgage.

Here's how it can work with the most flexible of these flexible mortgage plans. Let's say you have a £100,000 mortgage, £5,000 in credit card debt, £10,000 savings in a deposit account and £25.14 in credit in your current account on the third day of the month (sound familiar?). You now have two options:

a)      You can choose to pay the interest on the mortgage, pay the higher-rate interest on the credit card debt, receive the interest on the £10,000 and receive the interest on the £25.14. This is the way things conventionally work.

b)      You can choose not to receive the interest on the £10,025.14 you are in credit and instead offset this credit amount against your debts, starting with your highest-rate debt first, i.e. your credit card, and then your mortgage. So, although you won't receive any interest on your credit amounts, you also won't be paying any interest at all on your credit card debt which sucks up £5,000 of your credit balance and will only be paying interest on a mortgage amount of – let's whip out the calculator – £94,974.86. (£100,000 - £5025.14, see?)

You win the banana if you figured out that the best option to choose was 'b. I mean, I wouldn't be writing the article otherwise, would I? There are two reasons why 'b' is the best option. Firstly, you're using your credit balance to avoid paying interest at a higher rate than you could ever hope to receive in a deposit account. Here are some numbers which show the potential savings if you choose option 'b':

Option 'a'

Credit card debt of £5,000 @ 11% costs £43.67 per month
Mortgage debt of £100,000 @ 7% costs £565.41 per month

Interest on Savings of £10,025.14 @ 5% provides £40.84

Net monthly outgoing using option a = £568.24

Option 'b'

Flexible mortgage debt of £94,974.86 @ 7% = £537.00

Dramatic numbers, no? You're £31 out of pocket by using the conventional option 'a'.

It gets better, though, and the second reason why option 'b' is better is because of tax, or rather the lack of it. You pay tax, of course, on income received, but not on interest not paid. If you're a 22% taxpayer, you receive only £31.86 in income after tax on your £10,025.14 deposit in option 'a'. If you're a higher rate tax-payer, you receive a measly £24.50 per month.

Adding tax into the equation, a basic-rate tax payer using option b saves £40 and a higher-rate tax payer saves just less than £48.

It's hard to find much of an argument against flexible mortgages, which are a highly efficient, especially tax-efficient, way of managing your money and getting the best value you can out of your mortgage debt. In this example, even the basic-rate tax payer is saving nearly £500 per year. The only convincing argument against these mortgages is if you're the type who has no control at all over yourself and is likely to go and draw huge amounts out of your mortgage to blow on the horses. If that's the case, you probably shouldn't consider getting a flexible mortgage, but then you're not likely to be visiting the Motley Fool and reading this article, are you?

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