Pick and mix

When it comes to choosing a mortgage, you may be very sure of your circumstances and know exactly what product you want. However, many people, particularly first-time buyers, don’t know what the future will hold, and would like a loan that can take account of their changing needs. That’s where a flexible mortgage comes in.

There are two basic types of flexible mortgage: an ordinary loan with additional features in the contract, such as the ability to make underpayments and overpayments without incurring charges; and the sort that is linked to a current account or savings account – commonly known as an offset mortgage.

Flexible mortgages

A fully flexible mortgage will have the following features:

• Interest is calculated at least monthly, or preferably daily
• You can make overpayments, preferably unlimited, but sometimes up to a certain maximum percentage of the loan
• You can reborrow overpayments
• You can make underpayments
• You can take payment holidays

Many modern mortgages, even those with fixed rates, have at least some of these features, typically allowing repayment of up to 10 per cent of the capital each year without charge. Some will allow you to ‘borrow back’ overpayments, as long as your repayments generally stay on track.

The savings that can be made even with small overpayments can be dramatic. The Mortgage Advice Bureau (MAB) says that, on a typical capital and interest repayment loan of £100,000, over a 25-year term at 5.6 per cent standard variable rate, the repayments would amount to £186,020 at £620.08 a month.

Brian Murphy, lending strategy manager at MAB, says, however: “If the borrower makes overpayments of £50 per month, the total repayable would be just £171,579 and they would pay off the loan three years and seven months early, with a saving of £14,441.

The savings increase the higher the amount of overpayment. Using the same loan, a £150 overpayment each month would reduce the term by eight years and three months, saving a massive £31,965.”

James Cotton, mortgage specialist at broker London & Country Mortgages, says that, while the cheapest mortgage deals in the market will have the greatest number of restrictions and the fewest flexible features, lenders are increasingly including flexibility in their loans because they want customers to stay with them and not move on when their circumstances change.

“Borrowers like the idea of being able to overpay to reduce their loan if they get a bonus or a windfall, and for most the typical 10 per cent a year is more than enough,” he says.

Offset mortgages

If you want even more sophisticated features in your loan, such as a long-term drawdown facility, you will probably want to consider an offset mortgage.

Offset loans combine a mortgage account with some type of credit account. The simplest allow you to have a home loan and a savings account within the package, and deduct the notional interest you would have received on your savings from the amount owing on the loan. The advantage here is that the arrangement is highly tax-efficient, particularly for higher-rate taxpayers, because there is no tax to pay on the savings element.

For instance, if you have borrowed £150,000 and have £1,000 in savings, you would pay mortgage interest on only £149,000.

You may find that the APR (annualised percentage rate) is higher on an offset mortgage than on a straight repayment mortgage. But the convenience of an offset’s features can outweigh the disadvantage of a slightly higher rate.

Jackie Moran, head of sales at Standard Life Bank, whose Freestyle flexible mortgage was one of the first to enter the market in 1999, says: “A flexible mortgage can be a useful tool for financial planning. If you take full advantage of how it works, you would use your mortgage loan to pay for a new car instead of taking out a personal loan.”

Mortgage bank Abbey says its Flexible Plus lifetime tracker offset mortgage appeals to customers whose incomes can vary from month to month, such as people with commission-based income; the self-employed, who need to save to cover a later tax bill; or employees who receive an annual bonus.

Jeff Scott, Abbey’s head of mortgages, says: “When customers first apply for the loan, they can ask for more than they actually need to complete the house purchase, but leave it in the offset facility. They can then draw on the extra funds when they need them, paying the same rate of interest as the main loan.”

Some accounts, such as Cheltenham & Gloucester’s Offset Saver, Newcastle Building Society’s Family Offset Investment Account, and Yorkshire Building Society’s Offset Plus, are able to bundle together the savings of various members of a family to offset against the mortgage borrower’s interest, while keeping their own savings in separate accounts. This device is useful for, say, parents who want to help their first-time-buyer children.

Not all offsets are necessarily more expensive than a ‘plain vanilla’ loan. Broker John Charcol is offering a two-year tracker that has no premium for the offset facility. The arrangement fee is an eye-watering £2,499, but for mortgages over £300,000, Charcol says it is the undisputed market leader, even without the ability to offset.

Ray Boulger, senior technical manager at John Charcol, says: “Even for loans below £300,000 it offers great value. When offsetting was introduced, the premium for such a facility was well over 0.5 per cent on your rate, making it very much the privilege of those with a large savings balance. With this product, the gap between rates has vanished, and for large loans you are receiving the offset facility as a freebie.”

Current account mortgages

The ultimate in offsetting runs a mortgage loan and a cheque account within the same arrangement – like a giant overdraft. It is not for the faint-hearted or undisciplined, but the way it works can mean that a mortgage is paid off far more quickly than by having loan and cheque facilities held separately. Two of the main players are the One Account, part of Royal Bank of Scotland, and Intelligent Finance, part of HBOS.

Each month your salary goes into an account that also contains your mortgage. This has the effect of temporarily reducing the amount of capital owed on your loan – and at the same time the interest that you need to pay.

As each month progresses, you will need to draw down on the loan again for your household outgoings and the capital outstanding will rise again – although, over time, the idea is that the capital reduces bit by bit.

Expect to pay a little bit more in interest-rate terms for a current account mortgage, but, if you use its features to the full, it could be the right option for you