We look at how to decide whether you should go for a new, flexible mortgage or a straightforward discounted deal.
Two of the best financial inventions ever to arrive in the UK are offset and current account mortgages (CAMs). Before these arrived, we Brits had to put up with expensive, clunky, old-fashioned home loans.
Until the late 1980s, every mortgage lender offered only one home loan: its standard variable rate product. However, 1989 saw the arrival of the first fixed-rate mortgage, followed by capped-rate loans in 1990. Finally, the first flexible mortgage arrived about nine years ago (an Australian import), and has become a very popular product indeed.
Here are the best features of offset mortgages and CAMs:
- Interest rates lower than the standard variable rate = pay less interest
- Repayments credited immediately and interest calculated daily = pay less interest
- Flexible repayments = can overpay, underpay, take payment holidays and pay your loan off earlier
- Savings used to offset mortgage debt = only pay interest on the difference
- Offset balances reduce mortgage debt = earn tax-free interest at your mortgage rate
- (CAMS) current account balance also offsets mortgage = only pay interest on the difference.
So, you can see that these are miles better than the old-fashioned mortgages that millions of us hang on to out of sheer apathy!
However, if you're looking for the lowest monthly repayments you can find, rather than great flexibility, then an offset mortgage or CAM might not be the best deal for you. You may get a better deal by taking out a tracker mortgage or a loan with a discounted, capped or fixed interest rate.
This is because you pay for flexibility, particularly with a CAM, through higher interest rates, typically 1% more than decent reduced-rate deals. Let me give you an example by contrasting two home loans:
CAM
Mortgage of £100,000 minus credit balances of £20,000 = net debt of £80,000
Interest rate = 4.75%
Monthly interest repayment = 80,000 x 0.0475 / 12 = £316.67
Reduced-rate mortgage
Mortgage of £100,000
Interest rate = 3.75%
Monthly interest repayment = 100,000 x 0.0375 / 12 = £312.50
Monthly interest earned on savings of £20,000 at 3.5% interest, taxed at 40%
= 20,000 x 0.035 x 0.6 / 12 = £35
Net monthly interest paid = 312.5 - 35 = £277.50
Saving over CAM = 316.67 - 277.5 = £39.17
So, if you're not bothered about flexibility or offsetting, or you have a low level of savings, you're probably better off going with the mortgage offering the lowest interest rate that suits your needs (just make sure the interest is calculated daily). You can then save the difference and use it to reduce your mortgage balance when your special-rate deal expires (or whenever you can overpay without penalty.)
Finally, re-mortgaging every few years - whenever you can do so without penalty - will also save you thousands over the long term.
More: Mortgage Disloyalty Pays Handsomely | 21st Century Mortgage Centre
