Offset Mortgages. A dream for well off homeowners.
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Offset Mortgages: A Game Changer for Wealthy Homeowners
Introduction
Offset mortgages are rapidly gaining popularity, particularly among higher tax earners. But what makes them so appealing, how do they work, and is there a downside? Let's explore these questions in detail.
Understanding Offset Mortgages
Offset mortgages have emerged as one of the most significant innovations in the mortgage market. Just six years ago, they were virtually unheard of, but now they make up £10 out of every £100 of new lending. In fact, one major UK lender suggests that 25% of current mortgage holders could benefit from switching to an offset mortgage. If you're in the market for a mortgage, understanding them could be crucial.
How Do Offset Mortgages Work?
The concept is straightforward. Besides borrowing from a mortgage lender, you maintain savings or deposit accounts with them. Your interest is calculated on the mortgage amount minus your savings balance. For example, with a £100,000 mortgage and £20,000 in savings, you only pay interest on £80,000. In this setup, you don’t earn interest on your savings?"it’s offset against your mortgage.
Why Are They Beneficial?
The primary advantage lies in tax efficiency. The reduced interest means you effectively haven't received any interest income, so you pay no tax on it. This feature is particularly attractive for higher-rate taxpayers who might otherwise lose 40% of their interest earnings to taxes.
Consider this: On a £100,000 mortgage at 4.69% with £20,000 on deposit, a traditional mortgage over 25 years could cost £85,351 in interest. With an offset mortgage, you'd pay just £41,998, saving £43,353 and repaying the mortgage five years and eight months earlier. This means substantial tax savings: £9,538 for standard taxpayers and £17,341 for higher-rate taxpayers.
Additionally, offset mortgages offer flexibility. You can pay off capital without penalties, underpay, or take payment holidays if you've made sufficient overpayments.
Is There a Catch?
Historically, offset mortgages came with higher interest rates. However, with increased competition, these rates are dropping. Still, it's essential to ensure that the tax savings outweigh any additional interest costs. This calculation can be complex, so consulting a professional mortgage advisor is recommended.
As a rough guide, a standard taxpayer would need around £20,000 in savings on a £100,000 mortgage for an offset to be beneficial over a traditional mortgage. For higher-rate taxpayers, the necessary savings drop to around £10,000.
Different Types of Offset Mortgages
Not all offset mortgages are created equal. Many lenders compete for business by adding attractive features, such as free property valuations or legal work. Some include current accounts in the offset calculation, allow multiple savings accounts, or offer additional borrowing options.
You're likely to be offered various introductory rates, such as low fixed rates for six to twelve months or trackers below the Bank of England base rate.
The interest rate might also depend on the percentage of the home’s value you’re borrowing. For instance, one lender offers 5.6% for loans under 50% of the property’s value, rising to 6.45% for nearly full valuations.
Conclusion
While the core idea of offset mortgages is simple, the variations can be complex. Consulting an independent mortgage advisor is crucial to ensuring you secure the right type of mortgage and the best deal. If you have savings, there's a strong chance they'll recommend considering an offset mortgage.
Please note, figures are indicative as of November 2005.
About the Author
Michael Challiner brings 15 years of senior-level experience in financial services marketing.
If you have savings, considering an offset mortgage might just be the best decision for you.
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