Offset mortgages have become the flavour of the month for many borrowers but are actually the “privilege of the wealthy”, one of Britain's biggest mortgage brokers has claimed.
Recent figures from the British Bankers' Association show that the average mortgage has more than doubled in the past six years to £112,000. As people stretch themselves further to get on the property ladder, the appeal of getting rid of the mortgage millstone more quickly has pushed up the popularity of the offset mortgage.
Yet The MarketPlace at Bradford & Bingley says that unless borrowers with a £100,000 mortgage using offset products have at least £30,000 in savings they would be better off with a traditional market-leading mortgage with some flexible features plus a top rate savings account. Since it estimates that only about 3% of Britons have this much in savings, The MarketPlace's conclusion is clear.
Far from helping most borrowers to save money these offset mortgages, in most cases, leave borrowers worse off, The Marketplace says.
The offset market has proliferated over the past year with many lenders now offering this type of product. However, the MarketPlace says the majority of the current deals available are at uncompetitive rates compared with traditional deals, and if borrowers do their homework they will find that offsetting makes little sense for most of them.
“With just 3% of savers having over £30,000 in savings it is clear that most borrowers should avoid uncompetitive offsets,” says David Bitner, head of product operations at The MarketPlace. “Lenders are promoting these products and stating that borrowers will be financially better off by using them. In most cases this is simply not true.
Though they do provide flexibility and some products even allow borrowers to include current accounts, credit cards and loans, Bitner points out that this convenient, highly flexible mortgage could end up costing more in the longer term.
“Many people mistakenly think they need an offset deal to take advantage of flexible features but many mainstream mortgage deals offer much better rates with overpayments, underpayments, and payment holidays,” he adds.
The argument is compelling when you look at the maths. A borrower taking a £100,000 repayment mortgage over 25 years who offsets £30,000 worth of savings against it will pay interest on £70,000. At a typical offset rate of 4.59% – 1.09% above the Bank of England base rate which was at its lowest point for around half a century before last week's rise to 3.75%- the monthly payments are £561. It will take 18 years and eight months to pay off the loan.
If the same £100,000 mortgage was taken out at a rate of 3.3% over 25 years, with no savings to offset, the monthly payment is £490. If the borrower raised this to the equivalent monthly payment of £561, thus overpaying and taking into account the interest on £30,000 of savings, then the monthly payments he could potentially make are £663.50. At that rate the mortgage would be cleared in 16 years – two years and eight months ahead of the offset product.
The one thing that The MarketPlace assumes – possibly wrongly for most people if the savings are held in a standard account – is that no tax is paid on the interest.
“The message is clear,” says Bitner. “Until offset mortgages are offered at competitive rates borrowers adopting a proactive approach to their mortgage and savings will see bigger financial benefits over the mortgage term taking the traditional route. Reviewing mortgage and savings rates at least once a year is a must. The scenario above should make it clear that anyone who thinks there is no point in saving should think again.”
Whilst it may be appealing to think that once you have sorted out an offset mortgage you can forget about it for years to come, brokers generally agree with The MarketPlace's view. Robert Clifford, managing director of mortgageforce, says that in many cases it is the client who states a preference for an offset mortgage rather than the broker recommending it.
“Most mortgage brokers are lazy and will do what they have done for years and give advice on, say, the discount period,” says Clifford. “Offset products require a quite different approach. Brokers like an easy life if possible and mortgage broking is labour-intensive enough. Our experience is that a significant number avoid offsets.”
Clifford adds that although providers of these products market them in such a way as it appears most people would gain an advantage by using them, the reality is that there is only a degree of benefit available.
“You often compare products on price and for some offset products, discounts and capped rates are not available,” Clifford says.
The adviser's job can be made more difficult if the distinction between types of mortgages offering flexible features gets blurred. Kevin Paterson, managing director of Park Row Independent Mortgages, says it is important for both clients and brokers to understand the difference between offset, current account and flexible mortgages.
“Very often people put them into the same basket yet there are distinct differences,” he says. “The One account, for example, is really nothing like The Woolwich's Open Plan product.”
The Woolwich Open Plan, which is now offered through Woolwich's parent Barclays, is an offset product which has a rate of 4.35% and will go as high as 95% loan-to-value, although a mortgage indemnity premium has to be paid on amounts over 90%.
Like Open Plan, Intelligent Finance has an offsetting product. IF, part of the HBOS Group and one of the biggest players in the market, has a standard variable rate of 4.59% on its mortgage which is available with a three-month discount of 2.99%. You can choose to mix in your credit card borrowing at a rate of 8.9%, a personal loan at 6.9%-15.9%, a current account paying 2.75%, savings at 3.55% and an ISA at 3.9% which will change the rate you pay.
But if you are looking at using IF for a client you should make sure they are aware that the amount they pay per month will not change as a result of the offsetting – it is only the interest paid that changes. As a result, the loans are paid off earlier, says IF spokeswoman Jennifer Blackwood.
“No element of the product offering is compulsory so customers can take any combination of products or indeed have a product as a stand-alone,” she says. “This is the reason all our products are priced in their own right. And that's why we don't really have a typical customer.”
The One account, which used to be part of Virgin before being bought by Royal Bank of Scotland, is a current account mortgage. It is a single account that happens to have an overdraft the size of your mortgage, bumped up by any other amounts you may have borrowed. One of the biggest criticisms of The One account has been that people are put off by constantly seeing that they are, say, £100,000 in the red. As a result it has changed the way it shows the balance.
“You can now structure the account so you have 'pots', but you are simply looking through a template into a single account,” says The One account spokesman James Duffell.
This product has a headline rate of 4.7% for loans between 50% and 75% of the property's value.
Flexible mortgages as offered by the likes of abbey and Legal & General have no elements of offsetting but will also allow over and underpayments and payment holidays. Often the rates are lower than offsets.
However, Rod Murdison, proprietor of London-based Murdison & Browning, is not keen on one-stop shop financial products for another reason.
“I find that people don't like the idea of having all their eggs in one basket,” he says. “Having one institution knowing everything about your banking, credit cards and mortgage, and having your salary paid into their account too is OK if you know you are going to lead a blameless life forever. But there are advantages in being able to play one institution off against another.”
There is no doubt that the rates on offset, and even current account, mortgages are significantly higher than the best rates on the market and since most buyers are primarily rate driven it could be difficult for a mortgage broker to convince them of the need to take such a product. Then again the flexible features on offer are obviously proving appealing to borrowers so it is vital not to dismiss them out of hand.
Offset products can be particularly useful if someone is self-employed and has irregular income. Anyone who needs to pay a tax bill twice a year can also use these products to their benefit.
“The biggest beneficiaries of offset products, by a long way, are the self-employed,” says Murdison. “Given that they have to pay tax twice a year, rather than trying to save the money up it makes sense to overpay your mortgage by that amount every month and then draw it down when it is time to pay the bill. What other method is there which has the taxman helping you out?” Being able to draw down money on the mortgage at short notice is just one of the flexible features that has made offsetting so popular, another being daily interest rate calculations. But many other more traditional products offer similar advantages now, and at cheaper rates, so it is likely that many of your clients would be better off with a traditional lender that gives some, if not all, elements of flexibility. Charcol estimates that three out of four traditional mortgages now have some flexible features. Nationwide, abbey and Cheltenham & Gloucester already offer daily interest calculation.
However, another advantage of offsetting products could be in reducing the amount that someone is paying on other debts by consolidating them into one package.
Although most advisers are not driven to recommend products on the basis of the remuneration they will receive it is worth noting that the amount paid for an offset product sale is usually about 20% higher than on a standard mortgage. “The reason is that there is more work involved in explaining the product to the client,” says Park Row's Paterson.
Procuration fees to intermediaries tend to be slightly higher – on average 0.2% of the loan higher, says Barclays spokeswoman Emma Keens. “It is recognised that if this is the right product for the adviser's client, then that client is not likely to come back to the broker to remortgage in, say, two years as offsetting is about long-term savings,” she adds. “Also, products of this nature are more involved as the client needs to bring their savings and current account across to the lender.”
When mortgages come under the regulatory wing of the Financial Services Authority in October next year there may be some changes in the way advisers deal with the sale of these mortgages. But it is unlikely that any changes will be made to the products themselves.
IF claims that since it only launched in late 2000 it always had regulation in mind when it was designing the products. “Mortgage Day 2004 will have little impact on us,” says Blackwood. “The product structure will not change although some processes for the application will evolve, such as providing Key Facts Illustrations. The potential impact of regulation is already being communicated to staff in the form of briefings and newsletters.”
This is a market which will carry on growing. Cheltenham & Gloucester is one lender that is looking at the possibilities of launching an offset product.
“C&G does have plans for an offset and is looking into its viability. We hope to launch a product during 2004,” says spokeswoman Susan Knight.
Thanks to the recent popularity of offsets, we are likely to see more lenders enter the market, if for no other reason than to keep up with the trend and make sure their ranges of products are as appealing as those of their competitors.