Offset mortgages attract higher-rate taxpayers

Soaring inflation, record-low interest rates and increased competition between lenders are conspiring to make offset mortgages more tempting for higher-rate taxpayers.

With the Bank of England holding the base rate at 0.5 per cent again this week, while inflation, on the consumer prices index (CPI) measure, runs at 4.5 per cent, it is now almost impossible for wealthy individuals to get a real return from a savings accounts. Using cash to reduce mortgage interest can therefore make more sense.

“With interest rates unlikely to rise before next year, savings accounts will continue to pay poor rates of interest,” argues Melanie Bien, director of mortgage broker Private Finance. “Until this situation improves, borrowers can make their savings work harder by offsetting them against their mortgage.”

By switching to an offset mortgage – which deducts a borrower’s savings from their loan amount and only charges interest on the reduced balance – savings effectively “earn” the interest rate applied to the mortgage. For example, someone with a £400,000 mortgage and £50,000 in a linked savings account will only be charged interest on £350,000 of the loan.

“In an ideal world”, says Bien, “savers would have as much in savings as they owe on their mortgage, which would mean they would not pay any interest – while still retaining access to their savings in case of emergency.”

Offset mortgages can be particularly cost effective for people earning more than £150,000 and paying the 50 per cent top rate of tax. “This is because the savings do not earn any interest – which could be liable to income tax – but rather save interest at the prevailing mortgage rate, which does not attract any tax liability,” explains Nigel Bedford at Largemortageloans.com.

He calculates that a 50 per cent taxpayer with a 25-year £1m repayment mortgage at a variable rate of 2.79 per cent, and with £100,000 in savings, could save £28,687 in mortgage interest payments over the term.

As mortgage rates increase, Bedford says the benefits become even greater. Assuming the same mortgage on a 4.09 per cent five-year fixed-rate, the total interest saving becomes £66,655.

A further attraction of offset mortgages is that is that borrowers retain instant unrestricted access to their savings – so they can deposit or withdraw funds at any point. Some providers even allow offset accounts to be operated as a normal current account, with the daily balance offset against the loan.

Andrew Hagger at Moneynet says the main drawback to these loans in the past has been that the interest rate was higher than on standard mortgages. But he notes that the gap has narrowed significantly, with the average offset mortgage offering a rate that is just above a standard mortgage.

Defaqto, the financial data provider, says some 28 lenders now provide a total of 250 offset mortgages.

Woolwich, First Direct and Yorkshire Building Society are among the most active lenders in this sector of the mortgage market, with the latter now offering offset facilities on its entire range of mortgages.

Hagger says one of the most competitive products is the Woolwich Offset tracker mortgage, currently charging 3.29 per cent – 2.79 percentage points above Bank base rate, with a fee of £999. He also likes the Yorkshire Building Society three-year fixed-rate offset mortgage at 3.99 per cent with a £95 fee, and First Direct’s two-year fixed mortgage at 3.99 per cent, with a £499 fee.

But offset loans are not suitable for everyone. Borrowers who don’t tend to keep a lot in savings could be better off taking out a conventional mortgage at a cheaper rate.

“People who would benefit from an offset include those with ‘lumpy’ earnings – those for whom a significant proportion of earnings may be in the form of commission, or City bonuses, as well as buy-to-let landlords and parents paying school and university fees,” says David Black, an analyst at Defaqto.