Should you have an Offset Mortgage?
There are lots of different types of mortgage around these days, but one of those which has a lot of people scratching their heads is the offset mortgage. Although it’s a fairly simple idea, it can be quite tricky to get your head around how it actually works.
An offset mortgage basically links together all your money that’s in your current or savings account and offsets it against the balance of your mortgage. As most people have savings as well as their mortgage, when you link these two amounts together, you are using your savings to cancel out part of the debt of the mortgage which makes sense as it means you will pay less in interest overall.
Think of it this way. If you place £1000 in a savings account at 4% over 1 year you would earn £40 on it. BUT, you’d then pay tax on those savings at a rate of 20% – so £40 – 20% (£8) means you’d actually earn £32 over the year. If however you offset that £1000 against the amount of money you borrowed on your mortgage, and the mortgage interest was charged at 5% then you’d save yourself from paying £50 a year in interest. That’s a difference of £18 in your favour. (These figures are very much simplified as they don’t take into account daily calculation and are using an arbitory figure for interest rates. They are used here as an example only – you will need to do the calculations yourself based on your own savings and mortgage interest rates and of course this is based on the £1000 staying in the account for the whole year as well).
With an offset mortgage, you can use your savings account or current account (whichever the mortgage is linked to), in the normal way, making withdrawals and keeping your spare cash in there when you don’t need it.
There are two basic sorts of offset deal – the first is a current account mortgage (CAM) – this links your current account with your mortgage and is all held in one account so that on a statement you’d see a negative balance for the whole time of the mortgage. (i.e. if you had £50,000 mortgage and £1000 in the current account, what you’d actually see would be a negative balance of -£49,000). With a CAMs mortgage other debts like personal loans or credit card debts can be transferred to the account so that it all becomes one debt with the same interest rate across the board. The second type of offset mortgage is where you have separate accounts or jars for each item, but all these accounts are worked as one in terms of interest calculation. These are usually easier to deal with and see what’s happening as they’re closer to what most of us are used to working with. So each account (savings, current, mortgage) will be shown separately on a statement, in terms of the balance that’s in there, but the interest that you pay is calculated as if each of the accounts that are in credit (savings and current) had been knocked off the balance of the account that’s in debt (the mortgage) first.
Regardless of which of these offset mortgages you go for, you will normally make a regular monthly payment on the mortgage just as you normally would with any mortgage. For a repayment type mortgage this means that you’re knocking more off the capital sum with the aim of it being repaid by a particular date even if there was no savings to offset against it. In other words, the offsetting means that you are effectively over paying each month so that the term of the mortgage will be shorter, and you will be mortgage free sooner.
There are some advantages and drawbacks to offset mortgages; advantages can be that because you’re overpaying regularly, you can usually draw down on the account if you need to borrow more without having to re-mortgage to a higher amount as you are effectively just borrowing back the extra that you have already paid, and also as I already mentioned, the taxman never gets his hands on any of the interest. Disadvantages are that the interest rates are generally not as good as other types of mortgage/savings account on the market, and unless you have quite a large amount of savings, you can often be better off shopping around for a more traditional style of mortgage and then changing providers regularly, although this is changing as offset mortgages are becoming more competitive. The size of your mortgage and amount of your savings or salary also makes a difference, with a larger mortgage and higher savings and income, an offset mortgage can make a much bigger difference than it will if you have a lower income and smaller mortgage.
by Vialdana