Offset mortgages in view
by Cheyne Wilcocks MSc, DipPFS | 29th July 2019 | Insight
Let's start by taking a simplistic look at a lender's business model. To encourage savers to deposit their savings with them they will offer a competitive
rate of interest which they will add to the deposits at regular intervals. So how can they pay savers a rate of interest? They put that money to work
by offering customers loans and mortgages at higher rates of interest. This interest rate differential, the difference between the rate they pay their
depositors and the rate they charge their borrowers is where the lender earns its profits and meets the costs of its operating expenses.
So how does an offset mortgage work?
An offset mortgage, as its name suggests, enables you to offset your savings against your borrowings thereby
completely eliminating any interest rate differential. In a nutshell, whilst you have borrowings greater than your savings you will only ever pay interest
on the borrowings once your savings have been offset.
Consider the following illustrative scenarios
Let's assume you have a mortgage of £100000 with an interest rate of 5%. Each month you are paying £416 in interest payments
(we will ignore any capital payments). And let's assume you have savings with the same lender of £10000 earning you 1.5% in interest with £12.50 added to your account each month. If
we refer back to the first paragraph of this insight item you can clearly see the lender is paying you 1.5% on your savings and lending it back to you at a charge of 5%! They
have created a 3.5% differential representing possible profit.
If you had an offset mortgage with this lender before they charge any interest on your borrowings they will offset any savings you have
with them first. So, £100000 borrowings minus £10000 savings leaves £90000 net borrowings. This is the figure they will charge the interest on at 5% meaning you pay £375 each month in interest
on your borrowings but earning nothing on your savings. So have you saved any money?
Let's take a look -
Without offsetting you pay £416 [interest paid on your mortgage] - £12.50 [interest earned on your savings] = £403.50
With offsetting you pay £375 [interest on your mortgage] - £0 [interest on your savings] = £375
Representing a saving of £403.50 - £375 = £28.5 each month.
Moreover, if we bring capital payments back into the equation, if you are paying less in interest you will be paying more in
capital, effectively over paying your mortgage. This will help you repay your mortgage quicker.
What about the tax I pay on my savings income?
If you are offsetting your savings against your borrowings and you net out as a borrower, you are not earning any interest just paying it. Hence,
you won't have any tax to pay on interest your savings will not be earning.
So why don't I just overpay on a standard mortgage - isn't that just the same?
Well, no. Obviously it is good to overpay your mortgage when you can to speed up the repayment of it. But with an offset mortgage
you still have access to your savings. So if the unexpected happens you will not have to go through the process of a remortgage to capital raise should you
need cash to see you through.
Are there any disadvantages to an offset mortgage?
To make an offset mortgage viable you will need to have savings to offset otherwise you effectively have a standard
mortgage. If that is the case you may find there are better deals available with a standard mortgage than the ones offered by
Lawrie Mortgages will guide you through the mortgage selection process. Let us see if an offset mortgage
will meet your needs.
You can start your enquiry by arranging a callback.