Offset mortgages are very tax efficient. However, if interest rates rise offset mortgages will lose some of their appeal. Borrowers should therefore take advantage of low rates of interest while they can.
There is little doubt that an offset mortgage can be a very effective way of repaying a house purchase loan for a higher/additional rate taxpayer.
The concept of an offset mortgage is that in return for sacrificing interest (that would be taxable) on a deposit account, the borrower only pays interest on the excess of the amount of the mortgage that exceeds the amount held in the deposit account.
Where the borrower is repaying a fixed amount to the lender, any part of the amount that exceeds the interest payable will go towards repaying capital.
For example, published figures show that if a borrower had an interest only mortgage of £200,000 on which he/she was paying interest at 2.49%, he/she would pay £415 per month. If the borrower offsets £50,000 of savings against the loan, he/she would only be charged interest on the remaining £150,000. Repayments would fall to £311 per month.
Over two years, the borrower would save £2,500 in interest payments, an effective gross rate of return on their savings of 3.13% for basic rate taxpayers, 4.15% for higher rate taxpayers and 5% for those paying 50% tax.
The borrower could then, in effect, repay both capital and interest and so the savings would cut their mortgage term. For example, on the above assumptions, the mortgage would be cleared three years and two months early and save nearly £8,000 in interest.
Offset mortgages are particularly attractive at the present time because interest rates are low and so more money out of a fixed monthly repayment will go towards repaying capital which means that the mortgage will be repaid quicker. Yet, the saver still has access to the savings account should there be an emergency.
An increase in interest rates will, in theory, make offset accounts less attractive. Whilst interest rates are expected to start rising soon it is thought that it will still be some time before savings accounts, particularly those that offer easy access, start paying a decent rate of interest. Therefore offset mortgages may continue to be beneficial.
In essence, the benefit of offset loans is that they are very flexible. Borrowers have instant access and the peace of mind of knowing that their cash is earning a much higher effective rate of interest than if it was held in a bog standard deposit account.
However, it is not only wealthier borrowers who benefit from offset mortgages. Those with large amounts of cash moving through their accounts, such as landlords, should consider the use of offset loans. Also, self-employed borrowers who have to pay an annual tax bill can use the cash to reduce the interest they pay on their mortgage before they have to pay their tax bill to HM Revenue and Customs.
With the continued threat of an increase in interest rates, clients with offset mortgages should do their best to maximise their benefits while interest rates are low.