Saving grace

Offset deals appeal to a broadening range of consumers and their future looks rosy, especially if clients start to take a longer term view, says Murdo McHardy

The development of the offset and current account mortgage market has followed on from the growth in flexible mortgages over the past 10 years.

Originating in Australia, it took the flexible concept a step further and allowed borrowers to either have all their banking needs rolled into one account or link individual accounts so as to benefit from one overall interest rate.

As far as I am aware, First Active introduced the concept to the this country with its current account mortgage product in 1997, shortly followed by VirginOne in 1998. The Woolwich was first to launch an offset mortgage product, followed by Intelligent Finance in 2000.

Having welcomed the concept of flexible mortgages, home owners in this country are now starting to similarly embrace the concept of offsetting savings against borrowing to reduce interest costs, so reducing the term of their mortgages.

Today the market is becoming increasingly competitive as this niche area now becomes more and more mainstream. The market may not have reached the 25% some commentators predicted by 2005 but all the signs indicate increasing popularity. Much more product innovation is being seen in this area of the market and competitive pressures mean lenders are starting to reconsider the rates and fees charged.

Offset products have overtaken current account mortgages in popularity mainly because the majority of consumers prefer to keep pots of money in separate accounts as opposed to plumping for the all-in-one concept.

While current account mortgages offer the same appeal in terms of interest savings, my view is that they are only really suitable for those with real financial discipline. Offset offers consumers all the benefits but without the same risks, whether these risks are real or perceived.

Since 2000, the combined current account mortgage and offset markets have grown annually by 63.2% from 4.2bn in 2000 to an impressive 29.2bn last year. Offset mortgages account for the greater portion of this figure, at 22.7bn.

So what has spurred this impressive growth? Consumers are becoming increasingly aware of the cost of borrowing and how to manage their finances to keep interest costs down. As interest rates on mortgages have crept up steadily over the past two years, it has become more important for financially astute consumers and advisers to Tlook at products in this area.

Unspectacular returns on savings rates or stock market investments over the past few years have also encouraged us all to look for a better home for our short-term savings.

What better way than to reduce your monthly mortgage payments or the total amount you will pay in interest?

As bricks and mortar are seen by more and more people as an investment it makes sense to pay less interest on this borrowing and ultimately repay the borrowing earlier. The added advantage of course is that as the monies in the savings account do not actually attract credit interest – debit interest is simply charged on the net mortgage balance which is the mortgage balance minus any balance in the savings account – they will not be subject to Income Tax. For a higher rate tax payer this is a real bonus. The funds also remain immediately available should they be needed at short notice.

Marketing has also played a pivotal role in developing the market. The most intensive marketing campaigns were delivered by a small number of lenders when the products were still in their infancy and the concept little known.

The awareness however has now risen and as more lenders have entered the market, an increasingly competitive environment has required an increased marketing spend in a war to win customers. Some of the major players are almost doubling their spend from one year to the next. Lenders are also keen to attract business on this type of product as it naturally helps when it comes to customer retention.

As the market has developed, so too has the product offering and the type of customer these products were intended for.

Pricing has traditionally been pegged to the higher net worth individual who has a considerable amount of savings to offset against the balance of their mortgage.

Until recently most lenders charged a premium either by way of interest rate or arrangement fee for this type of mortgage which could be justified by the potential savings which could be made.

The relatively small number of competitors in comparison with the traditional mortgage market also meant that this pricing model was all that was on offer to consumers.

But as more consumers are “As monies in the savings account don’t attract credit interest – debit interest is charged on the mortgage – they are not subject to Income Tax”becoming switched on to the benefits of this type of facility and more lenders are picking up on this market opportunity, pricing strategies have started to move more into line with mainstream mortgage products. A handful of offset lenders now offer discounted deals such as Scottish Widows Bank, Abbey and The Woolwich. There has also been a lot of speculation among experts in the industry as to just who these products are most suitable for. The basic rule of thumb applied by many is that, due to the pricing of offset products, a client would need to be able to deposit at least 20,000 in order to make it an attractive proposition.

Offset mortgages are definitely suitable for those with larger balances to deposit – and especially so for those with irregular incomes or with tax bills to pay, for whom the savings can be substantial.

But it is important not to rule offsets out for your average borrower simply because they do not have 20,000 or 30,000 sitting about in a savings account.

The market is still evolving but there have been meaningful developments in terms of both product appeal and pricing that continue to make offset mortgages increasingly mainstream and suitable for a broader spectrum of clients.

As an example of this, offset is now available from some lenders against fixed rate pricing and even on a part and part basis whereby the client can have part of their mortgage – whatever proportion they wish – on a competitive fixed rate and the other element on a discounted or tracker rate with savings offset against this. This mechanism can help satisfy the risk appetite of those still wary of the uncertainty of variable rate products.

The growth levels that have been experienced in the offset market in recent years, combined with changing consumer attitudes and lenders’ competitive product pricing, all point toward a rosy future for the offset concept. Whether the market will soon account for that 25% of mortgage business is debatable, though eventually it will.

What will be interesting to see in the shorter term is how the product itself will develop and whether more borrowers will now start to consider this option as part of their overall financial planning, especially those who do not have large balances to place in savings accounts.

Will those with a smaller initial savings balance but the capacity to save regularly be attracted?

For offset mortgages to be truly appealing to the wider market it is not just pricing that has to be right. There also has to be a change in consumer attitudes.

At the moment the mortgage market in this country is primarily driven by rate and focussed on initial monthly payments. The objective of an offset mortgage is to save customers money on their mortgages over the longer term – reducing the interest costs and the term of the loan. This mindset will be hard to change but this is where product innovation holds the key.

Murdo McHardy is head of product development and marketing at Scottish Widows Bank