The offset alternatives

With consumers\' money having to work harder in light of the liquidity crisis, brokers should consider how offset and current account mortgages could help, says Mark Skinsley

With the emergency bail-out of US investment bank Bear Stearns by JP Morgan for a fraction of its original value recently, confidence in the banking community has hit a new low. The knock-on effect saw shares in the UK’s leading banks plummet as panic set in.

This, together with the high profile nationalisation of Northern Rock, paints a worrying picture of the lending market.

So in the current economic climate, is there more appetite for offsetting ?

The main selling point of offset mortgages is that they give borrowers the opportunity to use their savings to reduce the interest they pay on their mortgages. For example, an individual with £50,000 of savings and a £200,000 mortgage would only pay interest on £150,000.

Offsetting can save borrowers thousands of pounds and many years of mortgage repayments.

Research by Halifax shows that the average age of a first-time buyer is now 34. This is a substantial increase compared with 20 years ago when the average age was 27. This is unsurprising given that house price rises in that time have made it increasingly tough for aspiring first-time buyers.

“The upside is that this gives first-time buyers the chance to save for de-posits,” says Cammy Amaira, director of sales at Intelligent Finance.

So offsetting could be an attractive option for first-time buyers who have become accustomed to making savings over a long period of time.

Figures from Datamonitor show that in 2007, offset mortgages made up 10% of the mortgage market and at that time, they were expected to make up 30% by 2009.

These figures show the increasingly important role offset mortgages are likely to play in the mortgage market.

“It’s a good product and there are a lot of borrowers thinking about their mortgages and how to reduce them,” says Katie Tucker, technical manager at John Charcol. “They’re putting more effort into getting the right deals.”

Offset mortgages have flexible features, allowing over and underpayments according to circumstances.

Credits and debits are linked and offset against each other. While there are benefits to this increased flexibility, borrowers also need to be prudent in managing their finances, exercising control to benefit fully from the features available.

While some borrowers would like to tie all their savings to an offset mortgage, it’s worth exercising caution.

Borrowers should normally keep a certain amount of savings tucked away in case of future financial difficulties.

The main drawback with offset mortgages is the higher interest rates they command. Inevitably, many borrowers are still drawn in by headline interest rate figures for short-term mortgages, but this may not be wise in the longer term.

Offsetting could be a way of making long-term mortgages more attractive – something chancellor Alistair Darling wants to encourage.

For a borrower to benefit from an offset mortgage, they would need to place substantial savings in the offset account, making their interest repayments lower.

“Offset mortgages benefit borrowers with lump sums to deposit so they are particularly attractive to higher earners whose interest on savings is subject to a higher rate of tax,” says Tucker.

But do offset mortgages only benefit the rich or can they also play a role for consumers with more modest savings? With reduced interest payments not subject to tax, offsets offer a tax-efficient way of saving.

“For a higher rate taxpayer, who would normally see 40% of anyinterest on their savings accounts swallowed up in tax, this equates to an equivalent savings rate of 12% or nearly 9% if they are a standard rate taxpayer,” says Amaira.

The benefits of offsetting for higher rate tax payers is clear, but brokers should also be aware that clients with savings of 8% of their mortgage can still benefit from some forms of offset deals.

In fact, statistics from Credit Action show that the average outstanding mortgage balance is £99,090 and figures from National Savings & Investment show that average total savings are £18,566.

Using Intelligent Finance’s offset calculator, an average client would take six years and nine months off the term of their mortgage as well as saving £58,280 in interest.

“Offsetting is no longer a niche product – the concept has moved into the mainstream,” says Amaira.

David Hollingworth, mortgage specialist at London & Country, sees offset mortgages playing an important role in the future.

“People have always liked the idea of offsetting but it comes down to the competitiveness of their pricing,” says Hollingworth.

Pricing has come down significant-ly in recent years, making offsetting a more attractive option for an increasing number of borrowers.

It is also something lenders appear to have an increasing appetite for.

“Typically, offset mortgages used to be taken out by more savvy borrowers but that is beginning to change,” says Hollingworth.

With pricing becoming more competitive, offset options could become a secondary part of traditional deals.

“Many lenders are now capable of offering offset features on traditional mortgages,” says Tucker. “This shows the potential accessibility of offsetting to the conventional mortgage market.”

Given that the market for offsetting is growing, it is likely that more opportunities will soon be available to borrowers. One area that may gain support is linking other borrowers’ savings accounts to offset mortgages.

This may interest parents thinking of helping their children step onto the property ladder. While it won’t overcome the problem of affordability that is such an obstacle to many first-timers, an additional savings account linked to an offset mortgage could help reduce interest payments.

Some borrowers prefer to opt for current account mortgages. Their main feature is that they combine a current account, a mortgage, a savings account and personal loans into a single account.

The One account from the Royal Bank of Scotland adopts this holistic approach. A flat rate of interest, calculated daily, is paid on the overdraft. So by reducing the overdraft on the current account, borrowers can reduce the overall amount of interest they have to pay on their mortgage.

Current account mortgages work in a similar way to offset mortgages but rather than having separate current and savings accounts and mortgage debt, these are amalgamated into a single account. Borrowers are given a single cheque book and debit card.

Rather than paying off debt by making monthly repayments, any money paid into these accounts reduces the amount borrowers owe.

Lenders normally stipulate that customers pay their salary into their account. Again, this lowers the interest on the mortgage, which could mean paying it off early and thousands of pounds worth of interest savings.

One drawback with CAMs is that by lumping all their accounts together, borrowers are faced with the daunting prospect of a huge overdraft every time they check their balance.

Although this can be reduced over time, it can sometimes appear to be overwhelming.

Some providers allow borrowers to view their savings and borrowings in separate accounts. This approach provides a more balanced view and helps borrowers assess what they have to pay off. CAMs also allow borrowers to consolidate other debts. For example, cre-dit card bills can be linked to CAMs and paid off at a lower rate than would normally be charged by credit providers. Although convenient, this can lead to problems.

“If borrowers consolidate their other debts, they could turn six-year loans into 25-year loans,” says Tucker. “It’s important for brokers to convey the risk of this.”

Hollingworth says some individuals’ reservations about CAMs are a result of the ‘everything lumped in’ approach.

It can be hard to differentiate the savings from the mortgage parts of acc-ounts and some clients feel their salaries are swallowed up by the huge debt they see in their overdrafts.

The current account in a CAM operates as a large overdraft facility so it is important for clients to be disciplined.

“Generally speaking, the current account is difficult for clients to administer as it requires a lot of willpower,” says Tucker.

Borrowers who may benefit from this are those with regular positive monthly balances who can reduce their overdrafts and consequently the interest they pay steadily.

One group that can benefit from offsetting is the self-employed. Depositing money in a savings account linked to a mortgage can help alleviate the interest burden of a mortgage.

This money, when held for as long as possible, works more effectively by reducing mortgage interest repayments than if it was left in an ordinary savings account not linked to a mortgage.

The same applies to clients receiving bonuses, as money can be temporarily deposited in offset accounts.

While large savings will clearly make a big difference in reducing interest payments on offset mortgages, brokers should be aware that borrowers with less savings can still benefit from offsetting, as figures from Credit Action show. What is important is that borrowers show strong financial discipline or they will not gain the benefits of offsetting.

There is a difference between gross offset and net offset mortgages. The former let borrowers pay back their mortgages more quickly than the latter, which allow smaller payments over a longer period of time. This should be explained clearly by brokers.

ICM research commissioned by Intelligent Finance shows a healthy appetite for flexibility among borrowers. Almost half of respondents believe their current mortgage repayments are too restrictive, with nearly three-quarters being willing to increase their payments to cut mortgage terms.

With lenders offering increasingly competitive rates and borrowers hungry for flexible mortgages, it appears that offsetting is alive and well despite the current difficulties in the lending market.


A way for clients to become mortgage-free

Louise Cuming is head of mortgage and protection services at Moneysupermarket.com Offset mortgage products have a great deal of potential that too few consumers have discovered, so the challenge for us brokers is to compare like with like – in other words the true rate applied after offsetting funds against the rate applied on a non-offset equivalent. We also need to factor in the interest that would have been attracted to offset funds if they were in a savings or current account.

We must ensure we consider offset options as well as more traditional approaches. Granted, this may involve some calculations and true, offsetting is not for everyone but we must show that it is part of our portfolio and not left out of our considerations. After all, we are the experts.

The offset concept is straightforward – money held in a savings or current account or both is offset against money that is owed on a mortgage, thus reducing the overall debt and consequently the interest added to the loan.

Taking a holistic view of mortgages and savings could be an effective way to manage borrowing. Research in 2004 indicated that as many as one in four households looking for new mortgages could be better off with offsets, but offsetting still only accounts for 8% of the market.

Year-on-year growth for offsetting from April 2006 to March 2007 was 49% – more than three times higher than for non-offset lending.

As competition increases so does choice, while rates become increasingly attractive. It is important to shop around as the market is no longer dominated by a small number of providers.

Choosing an offset lender is about product features. For example the One account allows loans, credit card borrowing and mortgage borrowing all at the same rate and this may suit the requirements of borrowers who rely heavily on unsecured lending at times, as this will be at a significantly higher rate than the One account.

Intelligent Finance has a cash ISA that can be used to offset mortgage interest and Clydesdale Bank allows up to six current accounts to be offset alongside a mortgage.

Also, some offset lenders such as IF and Woolwich allow payments to be made at the level of net balance after deducting offset funds. Not all lenders allow this approach so again the requirements of clients is key to deciding if this feature needs to be considered.

Using the flexibility of offset alongside current accounts allows borrowers to benefit from salary deposits. If this is arranged while making household purchases on a credit card that is paid in full to avoid interest charges once a month, salary credit can stay in the current account until the credit card bill is due. So a couple earning £2,500 net each per month could reduce the interest rate they pay with IF by some 0.15% simply by using the funds they have more effectively.

Another option is to use funds raised on an interest-free credit card to sit in an offset savings account until the interest-free period is over, at which point the credit card balance can be repaid in full.

Both these options require a degree of financial discipline, which is probably a prerequisite for offset borrowers. But for the right client, taking out an offset mortgage can be a Eureka moment and one which could provide a fast track to becoming mortgage-free.

More offsets are being sold through brokers

Sally Laker is managing director of Mortgage Intelligence The offset mortgage market has undergone a dramatic transformation in the past 10 years and looks set to develop further as the concept plays an increasingly important role in the mortgage market.

Offset mortgages are not complicated but it has taken a lot of time and resource to educate brokers and borrowers about how they work, the benefits they offer and how they can fit in with individuals’ circumstances.

In the past decade, offset providers have been pushing hard to raise their profiles with brokers and drive home the benefits that offset mortgages offer. And because each product has its own peculiarities, training and education is going to be essential to keep the market moving forward.

For example, there has been a lot of talk in recent years about using investments such as equities and ISAs as part of offset mortgages. For such a move to be successful, brokers would have to understand how such an idea might work.

In the future, broker education will remain an important part of the offset market and those who get things right in this area are likely to do best. Already we are seeing the share of offset mortgages sold through brokers increasing dramatically.

We may see an increase in buy-to-let offsetting. For example, if a landlord was to keep his rental payments in a current account for most of the month, he could be cutting interest payments by offsetting his rental income against his mortgage balance.

Family offsets, whereby applicants can use their families’ savings to offset against their mortgages, is an area that Woolwich explored a few years ago and also one that could grow in popularity. This could be useful in situations where parents wish to help their children get onto the property ladder but still retain access to their money in case of emergency. Family offsetting could help to address the affordability issues that many young people face.

Figures from the Council of Mortgage Lenders show that between April 2005 and April 2006, brokers grew their share of distribution from 45% to 60%. The CML will be releasing up-to-date data in the next few weeks and it will be interesting to see how the figures for 2007 look and what effect the unusual conditions we are experiencing have on the market.

Anecdotally, there is evidence of a wary attitude from borrowers who are keen to make their money work as hard as possible. This is likely to play into the hands of offset providers.

It will also be interesting to see how the changes Intelligent Finance is making to its proc fees pan out. Some brokers use the IF product for its competitive rate and not the offset facilities it provides. IF is now changing its proc fee so that it pays more when applicants activate the offset accounts. This should stimulate brokers to educate their clients as to what offsetting can do for them, and further boost the market.

There have been many developments in the offset market recently and if the next 10 years are as productive as the past 10, this is an area that nobody will be able to ignore.

Current account mortgages can pay off for brokers and borrowers

Mel Buckingham is head of sales at the One account With only half a dozen lenders offering true CAMs in the UK, you could be forgiven for thinking that it is a niche sector. But CAMs have been around for well over 10 years now, so we need to treat them as a core part of the mortgage industry.

So let’s examine what a CAM is. A CAM pools a customer’s mortgage loan, savings and income into a single account. In this, the customer not only has their mortgage loan but also runs their current account where they can use a cash machine, a debit card, credit card or cheque book for purchases and ring-fence their savings. Deposits and withdrawals are recognised in the overall balance.

The premise is that any money that sits in the CAM – whether as savings or income – reduces the size of the overall loan. And because interest is charged daily, it also reduces the amount of monthly interest repayments.

One of the benefits CAMs offer customers is that they make it easier to pay off mortgages earlier. Every time money is paid into a customer’s account it brings down the size of their overall loan.

Borrowers become focussed on reducing this loan and tend to set themselves annual goals to achieve this. Seeing the size of their outstanding loan when they get a balance at a cash machine provides them with the motivation to pay it off as early as possible.

But CAMs offer many other benefits. For the growing number of self-employed individuals in the UK, a key benefit of having a CAM is a double whammy – ring-fencing money to pay Income Tax bills while at the same time reducing their monthly interest repayments.

More than 3.5 million people are now self-employed, much of this growth having been fuelled by the recent explosion in so-called white collar self-employment, with individuals setting up consultancies, agencies and doing freelance work in the service sectors.

Using CAMs, these consumers can avoid the headache of finding the money to pay their tax bills. They can pay everything into a CAM and then put away the money they need to pay their bills in a virtual pot. And while this money sits in their account, it makes inroads into their outstanding loan and their monthly interest rate payments.

Another benefit worth mentioning is that any money that sits in a CAM is exempt from Income Tax, as it is regarded as a mortgage rather than a savings account.

The borrow-back facility is also popular. For example, instead of taking a dealer’s finance package or applying for a personal loan to buy a car, a CAM holder could pay for it direct from their account without having to complete a lot of paperwork.

The rate they pay for this facility is the same as they pay for their mortgage, so it’s likely to be a better deal than they would be offered elsewhere.

CAMs offer great opportunities for brokers to generate income from other products. Because the self-employed have to look after themselves, brokers can talk to them about funding things such as increased life insurance, healthcare cover, critical illness cover, income protection and longer term retirement planning from the money they save each month by reducing their outstanding loans.

Brokers can also generate additional proc fees by helping their clients to get into or expand their interests in the buy-to-let market. For example, a client can borrow some of the money in their CAM to finance a deposit for a buy-to-let property.

A broker who helps a client to do this will obviously earn an additional proc fee for arranging the buy-to-let mortgage. And they can repeat this process as their clients build their portfolios.

With the mortgage market having changed significantly in the past 12 months, the opportunities offered by CAMs should not be ignored.

Not only do these products offer customers genuine flexibility in the way they manage their money, they also provide brokers with the possibility of growing their income streams.