25th June 2015
Nick Morrey, mortgage and protection consultant at John Charcol discusses the merits of offset mortgages…
Offset mortgages began in Australia in the 1990s and when they first came to the UK they were affectionately called ‘Australian Mortgages’. At the time they were very new but relatively complicated and with several varieties.
They have always been very flexible but until the last few years the difference in rates between them and traditional mortgages meant their take up wasn’t as high as lenders might have wanted. More recently their rates are much closer to traditional mortgage products so that now their benefits can be seen far more clearly.
Why choose an offset product over a normal mortgage?
We often take calls from people who are thinking of buying property in the future but want to get the borrowing plans laid out first. They may want a holiday home, or to start a buy to let portfolio, or maybe even extensive refurbishment plans. In these situations it could be that they just need initial funding or access to the complete amount. Either way an offset mortgage can be the most efficient method.
The way it works is that the lender sets up a traditional mortgage that is linked to a savings account. At the end of every day the credit balance of the savings account is subtracted from the balance outstanding on the mortgage account and interest is charged on this net balance. For example, if the mortgage is for £500,000 and you have £200,000 in the savings account then interest is charged on £300,000. Up until this point there is a case to simply stick with a traditional mortgage since it is more familiar. But it is the potential usages for ‘offsetting’ that many do not necessarily see.
If you have equity in your main residence and a capacity to borrow then you can borrow the maximum you may need at the outset. Then immediately pay back any excess money you do not initially need into the savings account. This savings account accrues no interest but all the time that money is in there you are not paying interest on it either. One day you decide to use that money (for a buy to let, holiday home etc) so you simply withdraw it from the savings account for any use you choose. It is at that point you start paying interest.
So let’s look at a common scenario we see at John Charcol. Mr & Mrs Campbell want to buy an investment property to rent out (or as a home for their children at university possibly). Their home is worth £900,000 and their existing mortgage is £150,000. They need £400,000 or a little more to get a rental property some time in the near future. Both the Campbells work but one receives sizeable annual bonuses. Their capacity to borrow is assessed at £600,000.
The recommendation could be to borrow £550,000 on an offset basis. The moment the mortgage completes there is £400,000 doing nothing but having interest charged. So the Campbells pay it straight back into the savings account. The net balance on the mortgage is now back down to £150,000. Six months later they find a holiday home they want to buy for £350,000. They can move swiftly on the purchase as they are technically cash buyers. No underwriting required. They just withdraw the amount from the offset savings account and transfer to their solicitor when required.
The advantages do not stop there though. If Mr Campbell receives further bonuses he can put all of it into the savings account so that it further reduces the net balance on the mortgage – a saving that is likely to be higher than if placed in a deposit account. Also, since the holiday home or rental property is being purchased cash then it could be in one person’s name only for tax reasons.
Furthermore, under current legislation, HMRC will normally allow the interest charged on funds raised on a main residence to be deducted from the rental income generated by a property purchased with those funds given an audit trail demonstrating where those funds originated. Your broker will advise that you consult with your qualified tax adviser to verify that aspect of the transaction.
These examples of potential uses do depend on various factors such as loan to value, affordability, rates, future income streams and current tax situations. However, until explored, the full savings and usefulness are often missed. An independent broker will be able to assess your current situation, your future needs and make an appropriate recommendation.