MortgagesOct 23 2014

Offset comes of age

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Once seen as a potential revolution in the mortgage market, offset mortgages are now firmly part of the Establishment. The offset mortgage in its truest form emerged from the flexible mortgage offerings from providers such as Standard Life Bank and, of course, the current account mortgage.

The Virgin One Account broke new ground in offering an all-in-one package that claimed to be all things to all men. It offered the first fully integrated flexible mortgage, where the current account was built-in and borrowers were able to pay in and draw back on their cash/mortgage.

Other than the interest rates being on the high side, the One account did suffer a touch from borrowers being uncomfortable with the concept and how it worked. The fact that the product was structured as a current account with a huge overdraft facility (otherwise known as the mortgage) meant that some felt unable to keep tabs on just what was savings and what was the outstanding debt.

That left a gap that offset mortgages could fill, ultimately becoming the preferred product choice within the flexible mortgage market. Tweaking the concept of the current account mortgage slightly saw borrowers being given the ability to keep their finances in the separate pots – current account, savings account and mortgage – but benefit from the credit balances reducing the overall interest bill.

The initial launches from Woolwich and Intelligent Finance were hailed as a new dawn as the mortgage market entered the new Millenium. There has been a lot of water under the bridge since then, of course. To put it into context, Woolwich was also launching some of the first mobile banking functionality, accessed through WAP technology on a Matrix-style phone so large that it could now be classed as an offensive weapon.

So how has the offset mortgage market fared, and what has changed since the product first hit the shelf?

The challenge for offset was initially to get the concept across to consumers. Awareness of offset mortgages was good, and borrowers, on the whole, had a basic understanding of the benefits. However, the next hurdle was to make the interest rates look attractive to the mass market in what was a very competitive marketplace.

That was a big reason why offset deals have in reality only ever managed to take a minority stake in volume terms and have largely been viewed as a product suited to more sophisticated borrowers.

Even now it is important for borrowers to really think about how they will use the product, and whether they will have a savings balance large enough to more than account for paying a higher interest rate. They are still of little value to someone who has a large mortgage, but only a small savings and current account balance, which quickly erodes back to zero as the month wears on.

Lenders have recognised that a broader product range with better rates would help improve their appeal, something worth doing given the expected improvement in retention of the borrower. Making fixed rates a viable offset option is a big step forward, when previously the desire for budgeting security was mutually exclusive from offsetting functionality.

The rates on standard mortgage deals compared with their offset cousins are now much closer. For example, Accord now offers offset options at only 0.20 per cent higher than standard products, and with Coventry it may only be a matter of a few hundred pounds on the arrangement fee. This narrower price margin makes offset an option that should be considered by a broader range of customer.

This product design improvement was largely down to greater competition, with most lenders seeking to develop some kind of offset deal. That saw differences in functionality, and many did not come with all the bells and whistles, offering only a savings account alongside the mortgage rather than full-blooded current account banking.

Other innovations came with the idea that offset accounts could be a useful way for the Bank of Mum and Dad to help their children without having to simply hand over their lump sum as a gift. Family offset is perhaps something of a niche offering, but gives a glimpse of how lenders could use offset to develop a broader product for other family members, as well as the borrower.

That has more recently been shown in the development of products by lenders such as the Family BS. This allows for the parental cash to act as security for the mortgage, enabling the child to borrow at a higher loan to value but with a lower rate and interest bill. This approach to the problems that have hit borrowers since the credit crisis shows the scope for offset to continue to provide innovative solutions.

But how has offset fared through the credit crisis?

With major tightening in criteria and a limited appetite for risk it was unlikely that the offset market would escape unscathed. Perhaps the most obvious symptom of that is the demise of Intelligent Finance, the brand developed by HBOS to champion offset. As one of the original offset lenders, its withdrawal from new lending was certainly a blow, particularly as it offered full-blown, integrated banking.

Other lenders reviewed flexible elements, such as the ability to drawback on overpayments or further borrowing facilities in the light of falling house prices. That led to some borrowers potentially denied the opportunity to pull back on overpayments, leading them to doubt the flexibility of their mortgage.

Ironically, the downgrading of those flexible features serves only to highlight the unique benefits of offsetting over flexible. As it got harder to withdraw equity, borrowers became hesitant about overpaying their mortgage for fear of losing access to their cash at a later date.

Offsetting avoids that problem, as any spare cash can be safely placed in the savings or current account, preserving liquidity and giving easy access to the funds when required. At the same time, the interest on the mortgage is cut, giving a much better effective return on the cash than putting it in a deposit account.

With the base rate at a record low, the dire returns on savings accounts means that offset mortgages have a very good story to tell. In a tighter mortgage market where lower loan to value opens up a wider choice of better rates coupled with derisory savings rates, offsetting can be a very effective use of cash. Driving down the mortgage balance more quickly, a strong return on cash without having to lock up the funds adds up to a strong proposition to deal with the market conditions in recent years.

Although offset has had a buffeting and has still not become the default choice for borrowers, it is certainly well placed to develop a growing audience. However, with the mortgage market review still bedding in, lenders have understandably not generally pushed the boundaries in terms of innovation.

I expect offset to remain a core product, as evidenced by the fact that it is now the primary, flexible option from Woolwich, given the removal of Open Plan. The notion of family offset offers potential for further development, particularly as the Bank of Mum and Dad remains key for many first-time buyers and more traditional guarantor options have fallen into steep decline.

Offset could also be a facility that landlords like the sound of, and although we have seen buy-to-let offset before, it is really only Clydesdale Bank that is offering an option.

With offset successfully making it into adolescence there is a strong case for its role in the modern mortgage market. For the right borrower it continues to offer great value and has every chance of maturing and growing older very gracefully.

David Hollingworth is associate director of London & Country Mortgages

Key points

* Once seen as a potential revolution in the mortgage market, offset mortgages are now firmly part of the Establishment

* It is important for borrowers to really think about how they will use the product

* Offset is expected to remain a core product