Let's start by taking a simplistic look at a lender's business model. To encourage savers to deposit their savings with them they will
offer a competitive rate of interest which they will add to the deposits at regular intervals. So how can they pay savers a rate of interest? They put that money to work by
offering customers loans and mortgages at higher rates of interest. This interest rate differential, the difference between the rate they pay their depositors and the rate they
charge their borrowers is where the lender earns its profits and meets the costs of it's operating expenses.
So how does an offset mortgage work?
An offset mortgage, as its name suggests, enables you to offset your savings against your borrowings thereby completely eliminating any interest rate differential. In a nutshell, whilst you have
borrowings greater than your savings you will only ever pay interest on the borrowings once your savings have been offset.
Consider the following illustrative scenarios
Let's assume you have a mortgage of £100000 with an interest rate of 5%. Each month you are paying £416 in interest payments
(we will ignore any capital repayments). And let's assume you have savings with the same lender of £10000 earning you 1.5% in interest resulting in £12.50
being added to your account each month. If we refer back to the first paragraph of this insight item you can clearly see the lender is paying you 1.5% on your savings and lending it
back to you at a charge of 5%! They have created a 3.5% differential representing possible profit.
If you had an offset mortgage with this lender before they charge any interest on your borrowings they will offset any savings you have with them first. So, £100000 borrowings minus £10000 savings leaves £90000 net borrowings. This is the figure they will charge the interest on at 5% meaning you pay £375 each month in
interest on your borrowings but earning nothing on your savings. So have you saved any money?
Let's take a look -
Without offsetting you pay £416 [interest paid on your mortgage] - £12.50 [interest earned on your savings] = £403.50
With offsetting you pay £375 [interest on your mortgage] - £0 [interest on your savings] = £375
Representing a saving of £403.50 - £375 = £28.5 each month.
Moreover, if we bring capital payments back into the equation, if you are paying less in interest you will be paying more in capital,
effectively over paying your mortgage. This will help you repay your mortgage that much quicker.
What about the tax I pay on my savings income?
If you are offsetting your savings against your borrowings and you net out as a borrower, you are not earning any interest, just paying it. Hence,
you won't have any tax to pay on interest your savings will not be earning.
So why don't I just overpay on a standard mortgage - isn't that just the same?
Well, no. Obviously it is good to overpay your mortgage when you can to speed up the repayment of it. But with an offset mortgage you still have access to your savings. So if the unexpected happens you
will not have to go through the process of a remortgage to capital raise should you need cash to see you through.
Are there any disadvantages to an offset mortgage?
To make an offset mortgage viable you will need to have savings to offset otherwise you effectively have a standard mortgage. If that is the case you may find there are better
deals available with a standard mortgage than the ones offered by offset mortgages.
Lawrie Mortgages will guide you through the mortgage selection process. Let us see if an offset mortgage will meet your needs.
Simple, get in touch. Before you do you may want to enquire about your credit file as your mortgage adviser will more than likely ask you for it as it
will form part of his research in finding your best mortgage choice. As with all mortgages there is no guarantee you will be accepted for mortgage following application but going through Lawrie Mortgages and letting us help you make the best mortgage choice will greatly increase your chances. Any successful mortgage application will rely on your own personal
circumstances which will include your income and affordability as assessed by the respective lender underwriting.
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