These are tough times for savers – it’s hard to get a decent rate of return. And a mortgage can be a burden at the best of times, with hefty monthly repayments stretching ahead for years to come.
It could be time to talk about an offset mortgage – a mortgage that gives your savings added firepower by using them to reduce the amount of interest you pay.
And because you save mortgage interest at a higher rate than you could ever earn on your savings, you end up with a very attractive deal.
As it takes savings into account, the idea behind an offset mortgage is that you have current and savings accounts with the same institution that provides your mortgage. You don’t earn interest on your savings, but your total credit balance is “offset” against your debt for the purposes of calculating interest.
So if you have a mortgage of £100,000, £5,000 of savings and £1,000 in a current account, the £6,000 of credit is notionally deducted from the debt before the interest is calculated, meaning you pay interest on £94,000.
In other words, you avoid paying mortgage interest on £6,000. If your mortgage interest rate is 5 per cent, you are effectively earning 5 per cent on your savings – and you are not paying tax, whereas interest earned on a normal savings or current account is taxed at 40 per cent or 20 per cent, depending on whether you are a higher or basic rate taxpayer.
The tax rates mean a (non-ISA) savings account paying 5 per cent, should you be able to find one, would only yield 4 per cent or 3 per cent respectively, depending on whether you are a basic or higher rate tax payer.
You can also trim your mortgage term. As well as saving interest, offsetting can reduce the term of the loan itself, perhaps trimming a couple of years off your mortgage if you can maintain savings at around 10 per cent of the capital debt. And as the interest is usually calculated on a daily basis, it doesn't matter if your “credit” balance fluctuates, as would be the case with a current account fed by your salary and used to pay your bills throughout the month. You have the comfort of knowing your funds are working against your mortgage interest bill the whole time they are in your account.
The attractions of offsetting are such that you might wonder why every mortgage is not arranged this way. The simple answer is that they are more expensive for lenders to administer because of the calculations involved, so they tend to carry a higher rate of interest.
It is an available option in the market place that you might want to investigate further, so shop around.
NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE. THE VALUE OF INVESTMENTS IS NOT GUARANTEED AND WILL FLUCTUATE. YOU MAY GET BACK LESS THAN YOU INVEST. PLEASE NOTE THAT THERE MAY BE VARIATIONS FOR THOSE LIVING IN SCOTLAND AND NORTHERN IRELAND.