"There has been a lot of coverage recently about offset mortgages and the resurgence in popularity of these products.
"Just last week, one of the high street building societies added an offset option to most of it's mortgage products and the broadsheet personal finance press have been beating the drum for these mortgages for a couple of weeks now.
"I thought it would be interesting to look at this in more detail - so here are three pros and three cons relating to offset products - for more in-depth advice, consult an expert.
On the positive side:
- Offset mortgages can provide borrowers with cost free access to funding which is available to you at any time. Given that offsets can be granted for up to 70% of the value of your home, this is often of a considerable amount of money.
This is a great security blanket for borrowers in uncertain times when access to credit from other sources might be more expensive and less forthcoming. Being able to draw down on a cost free facility whenever you want is a major benefit of offset mortgages.
- The net savings on interest rate payments you can gain by using an offset mortgage can be significant. Although any cash which would normally be held on deposit will not earn interest if placed into an offset product, with interest rates currently so low, this forgone return will be minimal.
However, since interest on a mortgage facility is paid out of taxed income (which means the effective interest rate is much higher than the headline rate) using spare cash to offset a mortgage facility can effectively save you paying the gross interest on the proportion of your mortgage that you can afford to offset using your spare cash. This is surely a good trade-off.
- Finally, for people who are self-employed who make deferred tax payments, particularly for high-earning self-employed people, the offset technique makes a lot of sense.
Using gross earnings to offset a mortgage and reduce interest or monthly payments until they have to pay the tax bill, is incredibly effective and can save £1000s in interest and repayment costs. As long as they are careful about ear-marking these funds for tax purposes, offset mortgages are a no-brainer for the self-employed.
However, borrowers beware!
- Borrowers should only consider opting for an offset mortgage if they are sure they have enough spare cash to make such a product worthwhile.
A small offset amount will not result in the same benefits as outlined in the positive points above, and borrowers who cannot really afford to offset should be careful not to be lured by the headline grabbing appeal of offsets.
- Banks and building societies are very reluctant providers of offset products because they make very little margins out of these mortgages. An offset mortgage requires the lending institution to allocate the full mortgage capital to the borrower, thus tying up capital on their balance sheet, but the very nature of offsets mean that the lending institution does not see much return on this capital.
As a result, interest rates can be high, criteria can be very strict and offset structures can vary in attractiveness. Some lenders use the offset to reduce the total amount of the mortgage, while not reducing the monthly payments - borrowers should be careful about these restrictions and mindful of different structures which might not allow them to realise the benefits of offsets.
- Finally, because they are not popular products for lending institutions, only a handful of lenders actually offer offset mortgages, although this has slowly been changing in recent weeks. As a result, rates for offset products are not the most competitive and remortgaging an offset can be an arduous, drawn out and expensive task."
