Why not consider taking out an Offset Mortgage?

By May 5, 2009Mortgage

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If you have savings and are about to buy a home or to remortgage, why not consider taking out an offset mortgage? This type of mortgage allows you to offset any savings against the amount owed on a mortgage, potentially saving you thousands in interest and allowing you to pay off your home loan several years early.

For instance, if you have savings of £25,000 and a mortgage of £100,000, you only pay interest on the difference – £75,000. Over time, thousands of pounds can be saved and this is especially attractive in the current economic climate. The offset mortgage has been around for ten years but in recent hard times has surged in popularity, thanks to competitive mortgage interest rates and the poor amount of interest paid on savings.

There are two types of offset mortgage: the standard type, which links all your accounts (savings, mortgage, credit cards, loans etc) whilst keeping them separate, and the current account mortgage, which brings all such accounts into one account with a large overdraft facility.

Although interest is not paid on any savings or current account, less interest is payable on your mortgage and there will be no tax to pay on interest made from savings. Also, substantial savings can be made on any linked credit card accounts: average interest on a credit card stands at around 16%, but offset mortgage rates are typically much less than this; with the base rate so low, this type of mortgage product can have an interest rate as low as 3%.

When used to full effect, it is estimated that an offset mortgage can shave almost nine years off a standard 25 year mortgage and save several thousand pounds.

Like many other mortgage products, most offset mortgages are conveniently flexible; they allow underpayments, overpayments, and payment holidays (in certain circumstances). This provides peace of mind for borrowers with fluctuating incomes (such as the self-employed) and allows people to conduct their mortgage according to their financial circumstances.

Advantages and Disadvantages of the Offset Mortgage:

Advantages:

  • Can save thousands over the long term
  • May pay the mortgage/credit cards/loans off much quicker
  • Flexibility
  • Most effective for those with substantial savings (totalling 10-20% of their mortgage) and those who save regularly

Disadvantages:

  • Rates are typically higher than those of other mortgage products (although they are competitive at the moment as a result of the unusually low base rate).
  • Discipline is required: if you are forever dipping into your savings or you only have a small amount saved, the product may not be for you – the key is to offset a substantial amount of savings against your mortgage over the long term.

Louise Bond, personal finance product manager at uSwitch.com comments:

“Unlike overpaying, offsetting allows consumers to access their savings at any time. For people that are nervous about the current financial situation, this could offer the most lucrative and safest alternative to a low rate savings account. Unfortunately, only 5% of mortgage deals currently allow consumers to offset but this is something that would change if the demand for offsetting increased. As consumer knowledge of offsetting is so low, it’s a bit of a catch twenty two situation.

Despite popular belief, you do not have to have a high savings balance to benefit from offsetting. As long as you have a mortgage rate that is higher than your savings rate after tax, you will be quids in by offsetting for as little as one year”.

Thanks to the benefits for savers, offset mortgages are becoming more popular and more lenders are gradually offering such mortgages, with tracker, capped and discounted offset mortgages available (although the majority tend to be on a variable tracker basis, moving in line with the base rate).

If you are thinking of taking out an offset mortgage, always seek the advice of a mortgage broker or independent financial advisor. Those with little savings may be better looking for a good rate on a fixed mortgage, in order to protect themselves against any sudden interest rate rises.

The table below shows the most competitive offset mortgages on the market at present (March 2009), all with a LTV of 60%:

Provider Initial Rate and Duration Rate Thereafter Overall cost for Comparison Early Repayment Charge
Scottish Widows 3.19 % for 2 years 3.99% for 276 months 4.1% APR 2 years
Woolwich 3.59 % for 25 years _ 3.8% APR 30/04/2012
Clydesdale Bank 3.69% until 30/04/2011 4.59% for 275 months 4.7% APR 30/04/2011
Northern Rock 3.89% until 31/03/2011 4.79% for 60 months, 4.54% for 216 months 4.8% APR 31/03/2011
Norwich & Peterborough Building Society 4.85 % for 25 years ­       _ 5.1% APR 2 years

Please let us know whether you have found any other great offset mortgages.

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