Save £13,322 On Your Mortgage
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This article was originally sent to Fools as a standalone email in our 'The Good, The Bad and The Ugly' email series.
If you don't know much about offset mortgages, I think you should take a look. They offer greater flexibility than conventional mortgages and they could also help you pay off your debt more quickly.
So how do they work?
You set up a savings account with your mortgage lender and the savings account is linked to your mortgage account. As a result, any savings you have don't earn interest; your savings are used to reduce the balance of your mortgage.
That's an attractive concept for three reasons:
- mortgage interest rates tend to be higher than savings rates, so your savings are generating a higher return for you
- you have flexibility. Your savings can be used to reduce your mortgage bill for a while but can easily be switched to somewhere else if they're needed.
- offset mortgages offer some tempting tax advantages.
So if you had a £100,000 mortgage with £10,000 in the savings account, you would only accrue interest on the £90,000 portion. And you won't pay any tax on the reduced mortgage interest that you pay.
A simple example
£10,000 in an account paying 5% AER would earn £500 in gross interest over a year - £400 for a lower rate taxpayer and £300 for a higher rate. Over 10 years a lower rate taxpayer would make £4802 and a higher rate £3,439.
At the same time, a £100,000, 10-year mortgage at 6% would accrue £33,224 in interest. By using that £10,000 to offset the loan (and effectively make it £90,000) you would accrue £19,902 in interest, a whopping £13,322 less.
So although a higher rate taxpayer would have sacrificed £3,349 in interest on his savings, he would have saved nearly four times this amount on his mortgage.
And if this taxpayer had needed the £10,000 at some point for another purpose, he could have obtained it quickly and easily.
Sounds good, eh?
Some lenders also allow you to link your current account to your mortgage as well.
What are the drawbacks?
Traditionally, offset mortgages haven't offered the best interest rates although they have become more competitive in recent years. In fact First Direct is offering an extemely competitive two-year fixed rate right now at 4.75%, and although the £1498 fee is very steep, you can take advantage of its offset facility. Check out our offset mortgages table for more details.
Unfortunately, offset mortgages aren't always offered at such market-leading rates, so you should make sure you're signing up for a good deal that will save you money overall. And not all mortgage lenders will allow you to link up your current account, as well as your savings account.
Another potential minus is that maybe they're too flexible. There's a temptation to take money in and out and you may not pay down your mortgage debt as fast as you could. That makes no sense.
You also need to have some savings in the first place, otherwise there isn't much point!
Who are they for?
Well, I think most borrowers should consider them, but they're best for people with significant savings who are higher-rate taxpayers. They're also particularly appropriate for the self-employed as they're often saving money throughout the year for the taxman.
Offset mortgages are also good for anyone lucky enough to receive big lump sum bonuses from their employers. I guess City high-rollers are the obvious example although I fear their bonuses are going to be much reduced this year. But that's for another day.......
If you'd like to find out whether an offset mortgage could work for you, get in touch with The Motley Fool Mortgage Service where one of our advisers should be able to help you.
