It is difficult to tell what proportion of mortgages are offset. Neither the Council of Mortgage Lenders nor the Bank of England (BoE) are able to provide any figures.
Consumer appetite is also hard to gauge, but a clue may come from research produced early last year showing the number of available products had dropped to a five-year low.
This drop came despite the BoE’s base rate remaining at historically low levels. But irrespective of whether interest rates are high or low, offset mortgages are suitable only for those with surplus money in their accounts.
With a conventional mortgage, the borrower has a loan on which they pay interest. Any non-wrapped savings they may have will earn interest, on which 20 per cent tax is paid if they are a basic-rate taxpayer, or 40 per cent if they are a higher-rate taxpayer. But there is no connection between the mortgage and savings accounts.
However, with an offset mortgage, the loan is linked to any qualifying savings, current, credit and deposit accounts, and the interest offset. So as borrowers do not receive any interest on their savings, there is no tax to pay and their money works more efficiently.
When the product was first introduced in the 1990s, the authorities viewed it as a possible tax avoidance scheme. However, the courts then ruled that since borrowers were not actually receiving any interest on their money, they could not be taxed on it. Instead they were effectively enjoying a discount on their mortgage loans.
The details
So, provided there is money in the qualifying accounts, the interest payable on the mortgage is being offset by the interest earned on the savings. As an example, take a borrower with a mortgage of £100,000 and savings of £40,000. They pay 1.65 per cent interest per annum on their £100,000 mortgage, which totals £1,650. If they were to offset their £40,000 savings against their mortgage, they might pay a slightly higher rate of interest, say 1.75 per cent, but they would pay it on a total amount of only £60,000, saving them £600 in interest.
Of course, they would no longer receive the interest on their savings, which are helping to offset the mortgage, but they would also no longer pay tax on the interest. The shift is equivalent to receiving interest at the same rate they are being charged on their mortgage, without paying any tax. As a result, the borrower can either reduce monthly payments, or continue to pay at the same rate and shorten the mortgage term.
Those who benefit most from offset mortgages are usually higher-rate taxpayers. They may be self-employed and need to set aside money to pay their tax bills, for example. Offsetting savings against their mortgage is likely to be a more tax-efficient way of using savings despite the loss of the interest.
But it isn’t simply about high earnings, either. Norman Phillips, director at Enhanced Wealth, recalling a client who earned £13,000 per month, noted that hefty outgoings meant their account would quickly move from £13,000 in credit to £17,000 overdrawn every month – meaning they were not suitable for an offset mortgage.
The premium
Lenders can charge borrowers a premium of up to 1 per cent for the privilege of having an offset mortgage, so there is no sense paying for the facility if it’s not going to be used. In recent years, the market has become more competitive and the premium has reduced. Not all offset mortgages are the same, either. Each lender will specify which types of account belonging to its banking group it takes into consideration for offsetting purposes. So the borrower may have to suffer the inconvenience of switching to another bank.
Apart from the tax and mortgage interest savings, another benefit for borrowers is that they retain control of their savings. Rather than using their savings to offset their mortgage, they could use it to pay off part of the mortgage. However, once they do that, they lose access to the money and can get it back only by remortgaging.
Mr Phillips acknowledges that some borrowers find offset mortgages difficult to understand so would rather steer clear of them. He adds that advisers can have their work cut out, too, in clarifying which accounts qualify to be offset against the mortgage loan. Some offset mortgages, for example, allow the savings of friends and family to be used to offset a borrower’s mortgage.
Mr Phillips says: “It gives the borrower a very powerful chequebook. Some get frightened of that, while others like to have money spread among a number of pots.”
Uncertain demand may have partly been responsible for a drop in availability. As of February 2016, the number of offset mortgage products stood at 233 – well down on the 370 available in 2015, according to Moneyfacts. Nevertheless, nearly 30 years after the products were introduced, they appear to have carved out an important niche for some in the business.
