Offset mortgages won't save you money
Filed under: Mortgages
First Direct claimed recently that higher-rate taxpayers could save £37,000 with an offset mortgage. The online bank, which is part of the HSBC Group, currently offers some of the cheapest offset mortgages. So how accurate is its claim?
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Offset mortgages allow you to combine your savings and your mortgage into one pot. You use your savings to reduce your mortgage, and therefore pay less interest. However, you can still access those savings at any time.
It can be quite intimidating to look at this big red minus balance in what's supposed to be your savings account.
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This negative figure only grows bigger when you come to draw out some savings, but in some ways it's more honest than saying you've got £5,000 in savings when you've also got £150,000 in debt. It could encourage you to spend more carefully.
The main selling point of offset mortgages, though, is that higher-rate taxpayers can face 40% tax on their savings interest when they use ordinary savings accounts - but they avoid this tax if they "save" by reducing their mortgage interest.
£37,000 of savings seems incredible
Even so, I found First Direct's claim of £37,000 of savings incredible.
Over the years, when I have compared offset mortgages to regular ones, they have not saved you money and you'd have been better off keeping your mortgage and savings separate.
In the past year or two, this has changed, because deals have changed. I have found that you could have made some savings with an offset if you were a higher-rate taxpayer. However, those savings didn't come close to £37,000 over the life of a mortgage.
So today I'm again looking at the best offset deal out there, and comparing it to the best non-offset mortgage used with the best easy access savings account. Let's see if First Direct is on to something or not.
The best offset mortgage
First Direct offers some of the cheapest offset mortgages available, possibly the cheapest, when you discard mortgages with poorer terms and conditions.
Take its best offset deal, the Base Rate Tracker Offset. With a 25% deposit, you can get an interest rate of 3.69%. This tracks the Bank of England's base rate for the life of the mortgage and comes with a £500 arrangement fee.
The best non-offset and savings account combo
The best comparable mortgage I could find that is not an offset is the HSBC Lifetime Tracker Mortgage, which has a lower interest rate of 3.29%.The mortgage comes with a £600 arrangement fee.
We need a savings account to go with it. The best easy access savings account at the moment, when considering the guarantees in its interest rate, is the ING Direct Savings Account. This currently pays 3.05%, which is 1.83% to higher-rate taxpayers.
How the two deals compare
Here's how the two deals compare after five years.
We'll assume interest rates don't change and that the same repayments are made on both mortgages. We'll also use First Direct's own figures. These are that the typical mortgage for our 40% taxpayers is £183,532 and that they have cash savings of £36,706.
"Net debt", if you're wondering, is the outstanding mortgage debt after five years, minus any savings. Since the first direct offset mortgage also functions as the savings account, there is just a £0 entry in the savings and savings interest earned box.
You'll save next to nothing with an offset
This shows that offset mortgages can still be cheaper, although the difference over five years here is less than £200. In other words, your debt could be £40 lower per year with the offset mortgage.
However, if you used the non-offset mortgage and put any of your savings into an easy access cash ISA instead of an ordinary savings account, even that small £40 advantage would disappear.
Some mortgage customers might benefit more and others less from an offset, depending on personal circumstances, the type of deal you want, and your savings. But it's hard to see how anyone could save £37,000 over the life of the mortgage from these figures.
Don't forget the mortgage rate
When comparing offset mortgages, most people and banks compare the offset mortgage rate to after-tax savings rates. However, it's usually even more important to compare the mortgage rates between the best offset and best non-offset deals that you can get.
Even an apparently small difference in mortgage rates can cut into – or wipe out – the advantages of offsetting.
It's because many people forget to do both that they make large miscalculations in the savings they could make with offset deals.
Remember also that if you suddenly need to take a good chunk of your savings out of your offset mortgage, all you're left with now is a more expensive mortgage. An alternative could be to go for an ordinary mortgage, but use a portion of your large savings pot to put down a larger deposit.
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