With rising interest rates, households and individuals will be looking for ways to balance their finances more carefully. One mechanism worth considering is the offset mortgage.
Background
Offset mortgages have fallen into relative abeyance in recent years. They are not suitable for everyone and can take some getting used to. Nevertheless, they remain a viable method for trying to reduce outgoings.
Have you ever wondered about the paradox between paying interest on your mortgage while receiving a less generous rate on your savings? This was particularly stark when earned interest was taxed more heavily than currently. The idea of an offset mortgage is that you have a linked savings account that technically attracts no interest and, thus, is shielded from the tax office and other parties. At the same time, you are only charged interest on the remaining balance of the mortgage.
So, if your mortgage is £100,000 and your savings are £10,000 then you effectively only have a £90,000 mortgage. Your monthly repayments will usually be taken out of your independent current account as normal. Mortgage interest is calculated daily and takes account of fluctuations in your savings and payments as well as any change in variable interest rates. As with mainstream mortgages, offset ones can also include options such as fixed rates and discounts.
Pitfalls versus advantages
As a result of any so-called offset benefit incurred, lenders may offer a choice between reducing monthly payments or decreasing the overall term of the mortgage. However, you need to be aware of any early redemption penalties and factor them in to your calculations. There are circumstances under which it is better to keep a mortgage going, even at a low level, rather than paying it off altogether.
Interest rates on offset mortgages have traditionally been higher than on conventional ones. However, some people find that the gains outweigh even this extra expense. When it comes to overpaying, offset mortgages are generally more flexible in the proportion that lenders will allow you to pay. Again, you will have the option to reduce the regular payments or the total mortgage duration. Alternatively, there is greater scope for increased borrowing if required.
In the unlikely circumstance that your savings are greater than your mortgage debt, you will not be granted interest on the positive savings balance. In other words, it will do nothing for you. This is more likely to happen towards the end of the term. If you finish your mortgage still with savings, the lender will channel them into one of its alternative types of account until you decide what to do. This may or may not pay interest.
Irregular earnings
Of course, not everyone has a large savings pot, as most of their money is ploughed into the mortgage. However, some people will come into large sums at times, followed by drought periods with relative paucity of income. The associated savings account acts as easy access via your current account. You can withdraw unlimited amounts as often as needed, up to the maximum held. However, there are always exceptions, and lenders’ terms and conditions of service should be checked judiciously.
Do not be frightened of an offset mortgage, but do make sure it will be appropriate for you and seek advice if necessary. You might also find The Motley Fool UK’s mortgage guide and mortgage calculator helpful.
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