Savers with large sums on deposit who also have a mortgage should think about doing the sums on ‘offset’ deals.
Inflation has risen sharply this year to 2.6 per cent and combined with paltry savings rates this means the value of cash is plummeting in real terms.
But by offsetting savings against a mortgage your money can work harder.
Watch out though as the higher interest rates charged on these loans mean savers need to be sure the benefits will outweigh the costs.
HOW OFFSET WORKS
Cash savings are offset against your mortgage debt so you only pay loan interest on the balance.
For example, if you have a mortgage of £150,000 and £30,000 in a savings account operated by your lender, you only pay interest on £120,000 of the debt.
Offset borrowers have two choices – pay a reduced monthly mortgage repayment based on the balance of their account, or pay the same monthly repayment (based on the full mortgage) – reducing the debt repayment more quickly.
Most offset deals allow unlimited penalty-free overpayments by deposits of further funds into the linked savings account.
Borrowers have access to all the funds in their savings pot, including overpayments.
In contrast, with a standard mortgage, there is usually a maximum overpayment limit of 10 per cent per year.
Borrowers are not usually able to get back these overpayments without going through a full remortgage process.
Interest is calculated daily so offset savings and overpayments are credited immediately.
HIGHER COSTS
Borrowers pay higher loan rates for the flexibility of offset. Among the main providers are Barclays, Accord (part of Yorkshire Building Society), Coventry Building Society and Scottish Widows Bank.
Two-year fixed rates start at around 1.2 per cent compared with 1.1 per cent for an equivalent non-offset mortgage.
Five-year fixed rates start at around 2 per cent, compared to around 1.6 per cent for non-offset.
As with standard mortgages the best rates are available to those with the most equity in their property (around 25 per cent for the examples above).
Lifetime tracker and variable rates are available, from both Barclays and Coventry.
Despite higher loan rates the effects of offsetting can be dramatic in terms of interest saved and in cutting the loan’s duration.
Speak to an independent mortgage broker to find out if it would work for you. You can find one through unbiased.co.uk.
BIG SAVINGS
A borrower with a £150,000 25- year repayment mortgage, who has £25,000 in savings to offset, could repay their loan 18 months early, saving more than £11,500 in interest.
This is based on a lifetime variable offset rate at 1.69 per cent with Coventry and assumes the savings balance is constant throughout. Borrowers need to have 35 per cent equity in their property and there is a £999 fee.
This is a variable rate and so it is likely to go up when interest rates rise in future, which will affect the overall savings to be made.
SAVINGS ACCOUNT
Choice is limited for savings accounts linked to offset mortgages and no interest is paid.
David Hollingworth, at mortgage broker London & Country, says: ‘Borrowers need to weigh up what features they need from an offset account, as well as considering the mortgage rate and fee.’
SAFETY NET
There is no need to worry about depositor protection limits. In the event of a lender going bust the mortgage and savings are offset so savings are not at risk.
But you would lose access to a big chunk of your savings. For example, if the mortgage is £500,000 and there is £400,000 in the linked savings account, the customer has a net debt of £100,000. Under the Financial Services Compensation Scheme the customer would get back £85,000 of savings from the scheme although the claim might take a while to be processed.
This would then leave a net debt of £185,000. Ray Boulger – mortgage expert at broker John Charcol – says: ‘Although a failed offset lender would result in a loss of access to most of a customer’s savings, the saver would be in a better position than if they had just had their savings with the institution.
Jo Thornhill