Cut your mortgage costs

Offset and flexible mortgages burst onto the mortgage scene roughly five years ago to a warm reception from UK borrowers.

And why not? These home loans give borrowers the option to overpay whenever they can, cutting down the total amount of interest payable on the loan. Another bonus is the potential tax efficiency, particularly for higher-rate taxpayers, because no interest and therefore tax is paid on the savings account. Most importantly, however, they give control back to borrowers over how they want to run their finances.

The popularity of flexible and offset mortgages has understandably leapt – as has the number of lenders offering them from six in 2000 to 29 this year, according to Moneyfacts.

But the increase in consumer interest, fuelled by heavy advertising and promotions from flexible mortgage lenders, has meant that some borrowers signed up for these more complicated loans, without a close look at how they would fit with their finances. In fact, an offset lender believes that up to 50 per cent of offset borrowers have signed up for an expensive host of ‘extras’ that they may never get round to using.

What are flexible and offset mortgages?

Flexible mortgages come in a variety of different packages, with variable rates in the shape of discounts and trackers and fixed interest rate options.

But all these loans give you the option to overpay your home loan, take a break for a set period from your mortgage payments and even borrow back cash from your mortgage.

Many lenders, like Nationwide and Skipton Building Society, already offer flexible features with their mortgage range. Other lenders go even further along the flexible route, offering loans called ‘offsets’, which allow borrowers to keep their savings in a separate account alongside their home loan, which ‘offsets’ the loan for as long as the cash stays there, cutting down the overall interest paid by borrowers. For example, if a borrower has £25,000 of savings, which remain untouched in a pot next to the mortgage account, and a £180,000 offset mortgage – the borrower only pays interest on £155,000 of the loan. Offset borrowers receive no interest on their savings but pay no interest on the portion of the home loan ‘offset’ by the savings, which can be tax- efficient for borrowers with considerable savings (see box on page 18 for current account mortgages – CAMs).

Mortgage lenders argue that the value of the interest saved shaved off the mortgage account far outweighs any interest customers would have made on their savings. However, in the UK, the earn and spend cycle of most mortgage borrowers means not everyone is likely to have the financial leeway to leave a lump sum of cash untouched over a long period.

Flexible benefits.

Overpayments are by far the most popular and valuable flexible mortgage benefit because extra payments shave down the capital borrowed faster than a monthly payment repaying both capital and interest. For example, according to Scottish Widows Bank, if you overpay £50 every month you cut three years and ten months off your mortgage term, saving yourself £12,022.47 in interest on a £90,000 repayment mortgage at an interest rate of 5 per cent.

Most flexible mortgages also recalculate your interest payments on a daily basis, with some notable exceptions including Bank of Scotland and Alliance & Leicester. But daily interest calculations are valuable because every payment, whether a monthly repayment or overpayment, cuts down the total amount of interest a borrower pays overall.

Flexible borrowers can also take pre-agreed payment holidays, for example in January after the excesses of Christmas, although these are best avoided if you want to pay off your loan early.

But examples include Standard Life Bank, which allows borrowers to take up to two payment holidays a year with their 180 or 360 Freestyle flexible mortgages after making six consecutive monthly payments, and Yorkshire Building Society lets you underpay for a set period, or take a break to the value of previous overpayments.

Are offsets for me?

The fact is that flexible, offset and current account mortgages are great on the upside but expensive on the downside.

Flexible-mortgage borrowers pay a higher interest rate than best-introductory-rate borrowers – around 1.00 per cent higher on average – so unless borrowers are disciplined and use the flexible options, many would be better off paying a lower interest rate on a standard mortgage.

“ If you’re the type of person who regularly spends all your money each month, even if you stay in credit and have no savings, the advantage of an offset mortgage will be minimal,” says Ray Boulger, spokesman, for mortgage adviser John Charcol.

A 2005 report from financial research firm Datamonitor suggests borrowers need savings of at least £5,000 to £10,000 to make any savings on mortgage interest. But the same report found that 39 per cent of offset customers had annual incomes of over £50,000, compared to 17 per cent of standard mortgage borrowers, which means that those more affluent offset borrowers will be in a better position to save each month and so make the most of their offset mortgages.

Standard Life Bank spokesman Andrew Boddie says their typical offset customer is in their late 30s or early 40s and on their second or third home purchase: “Our typical customer has a deposit worth 30 to 40 per cent of the mortgage value, is financially savvy and is the kind of person willing to get on the internet and research his or her finance options.”

It seems the ideal offset or CAM borrower has some money left in their current account at the end of the month and has the kind of erratic windfalls or bonuses which can be ploughed into overpayments. But the key is to look at your own financial circumstances. Work out how much spare cash you have roughly at the end of each month or over the year, recommends Boulger, then work out whether an offset would work for you.

Offset success.

Debbie Milsom, spokesperson for CAM lender the One Account, suggests 80 per cent of their customers are set to pay off their loans early, which shows that offsets and CAMs certainly work for some people.

And borrowers.

often stay with flexible, offset and CAM loans for longer because they appreciate the long-term benefit of these loans.

Linda Will, managing director at Accord Mortgages, suggests that many more people are suffering ‘remortgaging fatigue’, fed up with moving lenders every two or three years.

“ But the reality of life is that the number of people for which CAM and offset products really work is limited,” says Will.

“ CAMs are a niche product that work well for some, but a lot of people find it psychologically easier to manage their money in separate accounts,” says Will.

She adds: “The fact is, if people take an offset but don’t save, the mortgage lender wins and the borrower just ends up paying over the odds.”

Current account mortgages.

Current account mortgages (CAMs), offered by lenders like the One Account, Bristol & West and NatWest, are the most flexible option of all because your current account as well as your savings offset your mortgage balance.

Your current account, savings and mortgage balance are held in a single account. CAM holders spend or save as usual, with any money left over offsetting interest payments or overpaying their mortgage at the end of the month. CAM borrowers also need to pay all their direct debits at the end of the month to keep their account balance up for as long as possible.

Borrowers pay both their monthly income and savings into the account, maximising the benefit of offsetting as long as borrowers never go into overdraft or withdraw all their savings.