Offset Mortgages - An Interesting Anti Inflation Strategy

Using an offset mortgage is an interesting strategy for helping to defeat inflation, and one which many readers should further investigate.

An offset mortgage (sometimes called Offset Banking) is a system whereby your current mortgage, say £100k, is automatically offset against your cash savings, say £30k'. In some cases the balance in your current account will also be taken into account.

If the two accounts were separate you would have a £100k mortgage and £30k in savings, but the two combined means that the total borrowing is reduced to £70k. The mortgage also remains flexible, so if you need access to all or part of the £30k savings portion, the overall mortgage debt simply rises to counteract the amount which has been withdrawn.

Using the above as an example a person might need to withdraw £10k in cash which means that the mortgage loan moves from £70k to £80k. At a later date it is possible to pay back the £10k and so reduce the overall mortgage amount.

How Does An Offset Mortgage Help Fight Inflation

The benefit and anti-inflationary advantage with this type of mortgage comes in the form of tax savings.

In the above example if you had £30k in a savings account tax would be payable on the interest earned at either 20% (standard tax-rate) or 40% (higher rate). However, if the savings are used to reduce the mortgage loan there would be no tax to pay because no interest has been earned. So rather than receiving interest you pay a reduced monthly mortgage repayment.

By using an offset mortgage and as a rough rule of thumb lower rate tax payers can earn an equivalent rate on their savings of 7% per year and 9% for higher rate tax-payers.

How To Determine If An Offset Mortgage Is Right For You

Fortunately there is a simple equation that can be used to determine whether an offset is appropriate for you.

• Multiply the gross rate on your savings by 0.8 for lower rate tax-payers and 0.6 for those paying at the higher rate (this takes into account the impact of tax on your savings at either 20% or 40%)
• If the result is higher than your current mortgage rate you would be better off without an offset
• But if lower then seriously consider the benefits of an offset deal

  If a higher rate tax payer is currently getting 6.5% gross from his savings

  6.5 x 0.6 = 3.9% and with current mortgage rates around 5.75% an offset mortgage looks attractive

How Much In Savings Do I Need

Obviously if you have only have £1,000 in savings an offset mortgage is not going to be advantageous.

Experts suggest that in order for an offset deal to make financial sense £20k to £25k in savings per £100k mortgage loan should be the minimum.

How To Get The Best Offset Mortgage Deal

As ever the more research you do into what you're buying will mean you have a far better chance of finding a great deal. One area where I'd advise you really look into is the setup fees because they can amount to £1,000 - £1,500 or more.

It's therefore no good looking at just the interest rate, you must take note of ALL costs because only then will you be able to compare the different deals.

Offset mortgages are also somewhat specialist so you must use a broker to help find and advise on the market. In fact I would never use just one broker, I'd call at least 3 up and then play them off against each other.

Mortgages are a tough sell right now so it's a real buyers' market. I have no experience of using mortgage brokers but I have heard that John Charcol are worth a call.

If I was looking for an offset style mortgage I'd be on the lookout for one that offers a good deal of flexibility. You really cannot guarantee that your financial situation will always remain the same and never change significantly, either for better or for worse. Deals which tie you down for excessively long periods with expensive get out clauses are normally to be avoided.

Tax Planning Is Important

I believe an offset mortgage is not just another stand alone product. I actually think it makes a lot of sense to combine it with an overall personal finance plan as its nature is dynamic whereas a traditional mortgage is more one dimensional.

So if you do have reasonable cash savings as well as other significant assets, I think it would be wise to seek some professional tax advice if you have not already done so.

Tax, and hence tax planning, is never that simple for higher earners or for those with large assets and using a good tax accountant/planner is often a good investment. I call this 'accountant tax' rather than 'income tax'. Yes, of course you will have to pay for the advice, but a bill from a good tax accountant is often much cheaper than one you could receive from the Inland Revenue.

Offsets Can Shave Years Off Your Loan

Here's some interesting research from Intelligent Finance (a subsidiary of the banking group HBOS) which shows another benefit of offset type deals.

The table below looks at the effects of maintaining various savings balances on a repayment term, and the total interest paid on a £250k offset mortgage initially taken out for 25 years with a 5.49% fixed interest rate.

The bottom row shows that if a borrower held £50k in savings throughout the term it would reduce total repayments by 23.6% and pay the whole mortgage off around 5.5 years early.

Potential Small Print Problems To Look Out For

With most personal financial products it is the small print which does the damage to our wallets and consequently makes the juicy (and often very easy) money for the providers.

I've just spent the last few hours doing some detailed research into Offsets and a couple of points foxed me. I'd therefore strongly advise that if you think this style of mortgage is right for your circumstances, you must make sure that these two points are fully explained to you.

The Redraw Rate – This is to do with overpayments. Say you have a offset of £100k and savings of £30k the loan is obviously now £70k. Perhaps in the future you receive a £10k bonus and are going to use that money for a new kitchen in 6-9 months. In the meantime you use the £10k to further reduce your overall mortgage debt to £60k. All very simple.

Then in 7 months time you withdraw the £10k to pay for the kitchen, this in fact is referred to as a 'redraw'. Some banks will now only allow you to borrow back at a higher interest rate rather than the initial deal rate.

This is a confusing point and if it was me asking the questions I'd give a broker a few what/if type examples to explain the process in far more detail, and of course you must always ask what costs would be involved.

Different Interest Rates – Some lenders also offer different rates for the savings part of the account to the mortgage loan. So you need to check that the interest rate is the same for both elements otherwise you could have small amounts of interest to pay on your savings. Again, it's confusing so get a professional to explain these types of points in far more detail.

A Benefit For Financial Weasels

To call someone a weasel is no doubt an insult but to refer to them as a financial weasel, well many would take that as a compliment.

So if you're the kind of person who likes to seek out the best deals right down to the last penny then offsets that take into account not only your savings but also the cash in your current account are really going to peak your interest.

This is because interest is paid daily and therefore your current account balance is always taken into account.

So if you buy almost everything (food, petrol, snacks, drinks, clothes, bills etc) via a credit card (not debit card) then you'll be able to borrow that money interest free for around 1 month. This means there will always be a higher amount of money in your current account which will help reduce your overall mortgage loan and hence monthly repayments. The savings might only amount to £10 or £20 but some view the money as a bonus with the real thrill coming from playing the game/system to almost perfection.

Another tip is to arrange for all monthly direct debits and standing orders to be paid in the week before payday rather than just afterwards. This means yet more money sitting in your current account which is used to reduce the overall mortgage debt.

Summary

Although this article has gone into the overall merits and advantages of offset mortgages, in reality it has been about using them as an anti-inflationary tool and for this purpose they really do look like they offer a great deal of scope.

However, as I have indicated before I would strongly caution anybody who is thinking about an offset deal to -

1. Use 2-3 brokers to scope the market and offer advice (bearing in mind that advice is not always impartial as they will sometimes get paid more to push product A over products B and C), and

2. Study the small print carefully (or get someone more experienced to check it for you). Pay special attention to the specific interest rates paid on the loan/savings because that's where the lenders will probably play their tricks

Yes, researching personal finance products is not something most of us enjoy but in my experience it's imperative these days to make sure we truly have a chance of getting the good deals.

It doesn't have to take very long but this time investment could literally translate into thousands of pounds of savings over a multi-year period.

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