Despite promising not to increase tax rates, the government has increased the taxman’s take by freezing tax thresholds.
At the same time, the Bank of England has raised the base rate, and mortgage costs are higher than they have been for around 15 years.
An estimated 1.6 million fixed rate mortgage deals will expire this year. Many may see their rate double when they come to renew.
High tax and high mortgage rates are a toxic combination. But there might be a way to reduce both the tax you pay, and the cost of buying your home.
Introducing offset mortgages
Offset mortgages were introduced to the UK market in 2000 and were initially popular. They have been out of favour for years, but with recent rate hikes, they could make a great deal of sense if you have cash in the bank – because as well as cutting your mortgage repayments they could reduce the tax you pay.
An offset mortgage lets you offset a savings balance against your outstanding mortgage debt. In effect, they take the interest you would have earned on your savings and use it to reduce the amount of interest you pay on your mortgage. You can therefore pay less each month – or keep your repayments high, and pay off your mortgage, potentially years earlier than planned.
The lender will usually need you to keep both your mortgage and savings accounts with them.
Offset mortgages may have slightly higher rates than standard mortgages, and not all lenders offer them. But the potential interest savings from offsetting your savings can often outweigh the higher interest rate.
How much could you save?
Higher interest rates have made the potential savings offered by an offset mortgage much more worthwhile again.
Based on an interest rate of 6.22%, a borrower who secures an offset mortgage at 5.77% with a £225,000 mortgage and £100,000 in savings would be able to bring down their monthly payments from £1,480 to £960 – slashing their bills by £520 a month. It might alternatively let them become mortgage free several years earlier – how many years would depend on their mortgage term, and what happens to interest rates in the intervening period.
But the savings don’t stop there.
After years of rates being so low, few people had tax to pay on their savings. Higher rates mean that the taxman is taking an interest (and a share in) the interest your savings earn. With the most generous accounts now paying just over 5%, anyone with £20,000 or more in savings could find they have tax to pay.
And while basic-rate taxpayers can earn up to £1,000 before having to pay tax on their savings, higher-rate taxpayers get just £500 – while taxpayers in the 45p tax band get no allowance at all.
If you don’t earn interest on your savings because your interest is taken to pay your mortgage – you have no tax to pay. Satisfyingly, the portion of your interest that would have gone to the taxman is also applied to paying off your mortgage.
Are there disadvantages to an offset mortgage?
Offset mortgages are really only effective for those with a decent amount in savings. You would probably need to have 20% to 25% of your mortgage borrowing as cash savings to be worthwhile. This means that a borrower with the average mortgage debt of £127,000 would need at least £25,400 in savings for an offset mortgage to be worthwhile.
As you will need to remortgage to switch to an offset mortgage, you could, simply use your cash savings to pay off your mortgage debt – but with an offset you still have access to your savings if you need it. You can also add to your savings pot each month, meaning that your mortgage savings can actually improve still further.
Getting some help
Not all lenders offer offset mortgages, and finding one that is suitable for you and your financial plans and prospects can be far from easy. Fortunately, there is a simple solution.
Call us at Continuum, and we can not only advise you whether an offset mortgage is suitable for you – we will help you find the one that is appropriate for you.
Mortgage rates to drop below 4% (moneysavingexpert.com)
This is exactly how much you need in savings to beat the mortgage crisis (telegraph.co.uk)
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to a particular mortgage product and you should seek independent financial advice before embarking on any course of action.
Your home or property may be repossessed if you do not keep up repayments on your mortgage.
The Financial Conduct Authority does not regulate taxation advice and National Savings products.
Levels, bases and reliefs from taxation are subject to individual circumstances and may be subject to change.
You may have to pay an early repayment charge to your existing lender if you remortgage.
