Offset mortgages gain in popularity

Offset mortgages have proven to be a success in the mortgage world. These mortgages link mortgages and savings and they have really taken off in popularity.

In 2006 about 7% of all new lending was for offset mortgages at around 170,000. Between April 2006 and March 2007 the value of offset mortgages rocketed by 49%, compared with other types of mortgages whose value only rose by 15%.

The offset market continues to go from strength to strength. Yorkshire Bank recently said that four million UK homeowners could save a total of £29bn in interest and Income Tax if they moved their mortgages and savings to offset products – and that’s £11,000 per household. These people may already have a mortgage and savings with the same bank or building society, but have not combined the two into one offset product.

The advantages of offset mortgages are their flexibility in allowing overpayments or underpayments, lower interest rates and shorter mortgage terms. Also the savings that borrowers have already will effectively earn interest rates similar to those offered on mortgages – usually higher – and the savings income is protected from Income Tax. Offset mortgages really do allow borrowers to make savings work better to their advantage.

Savings in building society accounts do not earn a great deal of interest, but put into an offset mortgage the money can gain greater tax efficiency by earning interest at the mortgage interest rate. What really happens is that instead of actually earning interest on savings, offset borrowers pay less interest on the mortgage loan. As an example, if a borrower had a mortgage of £100,000 and savings of £20,000, then he would only pay interest on the £80,000 difference, rather than the full £100,000. This effectively means that they are getting the same rate of interest on the savings as the mortgage interest rate – and, as no interest is actually ever received, there is no tax payment due. These factors have a great impact.

According to the Council of Mortgage Lenders (CML) most offset products are sold via brokers. Although there are many offset products consumers can find them confusing. Offset mortgage can link more than one savings account to a mortgage, and can also link a current account to the mortgage. However, banking services offered on accounts coupled with an offset mortgage can vary: some operate like a regular current account, but others have restricted functionality. Some banks combine the mortgage account with the savings account and only produce one statement; others keep accounts and loans separate and they are only linked for the purposes of calculating interest.

Opinions differ on whether clients should maintain a certain level of savings in their accounts before they can take an offset mortgage, with some brokers believing that a client should have a minimum of £10,000 in savings account first. It is also beneficial for customers to keep as much money as they can in their savings accounts for as long as possible. Changing mortgage payments to direct debit also helps, as with offset mortgages every little bit helps to squeeze the best out of the deal.

Self-employed people or those whose income is sporadic often benefit from offset mortgages as there are opportunities to save money from their annual tax bill. Offset mortgages are also better for the higher paid who would otherwise be paying higher rates on their savings. Offset mortgages tend to be better for people who have savings which amount to at least 8% of their mortgage.

Some lenders even allow cash ISAs to be linked to offset mortgages. Barclays is one example. Savers would receive no interest, but don’t limit themselves to putting only £3,000 in the ISA. The ISA can be kept on and receive interest once the mortgage has been finally paid off.

History has shown that offset mortgages have had higher interest rates attached to them, but this is starting to change, and the gap between offset interest rates and other mortgage interest rates is reducing. In addition more fixed rate offset mortgages are expected to be available soon as more lenders decide they want to be part of the offset market.

Offset mortgages have been the most innovate mortgage product in years. Technology has helped with the integration of accounts and calculations made easier.

Currently there are around 250 offset mortgage products available – a huge leap forward in the six years since they came into being. Offset mortgages would suit savers who don’t want to lose access to their cash permanently by drawing on savings to pay off chunks of their mortgage. They also work well for self-employed and higher rate tax-payers.

Instead of being attracted by headline-grabbing interest rates, people should think longer term and look at the bigger picture, and offset mortgages look very good option in those terms.