Current account or offset mortgages have dramatically increased in popularity over the last 18 months. This is largely due to some of the major lenders launching products. As a result, the features and benefits of the offset arrangement are now delivered with the support of mainstream financial brands. This has increased the awareness of this type of product among consumers and mortgage intermediaries significantly.
Before examining offset and current account mortgages, it is worth taking a trip down memory lane.
There has been a continuous evolution of flexible mortgages over the last 15 years, which has moved from equity drawdown options through to mortgage offset and even third-party offset. The chart on page 22 illustrates this evolution that has turned a niche into a mainstream product.
The typical customer
So, what type of customer chooses an offset product? Our experience reveals the typical customer is married and in their second or third home. But unlike previous versions, the average mortgage size is higher than normal at £80,000 with around £12,000 offset. Based on a typical 25-year repayment mortgage, this means the mortgage term will be reduced by six years and six months with a saving of £25,500 in interest.
And the use of this next generation mortgage product has not been limited geographically and has been adopted nationally, rather than in the traditional heartlands that previous flexible mortgage have occupied.
Customers are choosing to offset their savings to repay their mortgage early and are making good use of their current account balances as well. Most current accounts pay virtually no interest so offsetting it against a mortgage makes good sense.
Offset customers receive an effective rate of return on their savings and current account balances of the mortgage rate ‘ tax free. Based on the current rate of 5.25%, this is 8.75% for higher rate taxpayers and 6.56% for basic rate tax payers.
This provides a good indication of when offset is suitable for a customer. If savings are held in a tax-free investment such as an Isa and the rate offered is above the mortgage rate, it would be inappropriate to offset it against a mortgage.
Opening new doors
This gives the adviser the opportunity to talk about a whole range of alternative financial planning activity. Naturally, with a current account or offset arrangement the savings are always instantly available and the effective rate of return is not linked to the performance of equities and is therefore risk free.
Customers who get the most from an offset mortgage are those with relatively high savings in low interest and taxable accounts. Also, those with high balances moving through their current account will benefit. Even though most customers will spend all of their income over the month, because offset mortgages calculate interest on a daily basis every day there is a credit balance there is a benefit.
However, offset mortgages are not suitable for everyone. Customers who want the security of fixed monthly payments, or have little or no savings are best advised to select a conventional mortgage. Depending on the size of the mortgage and savings balances, some customers may be better off with a discounted rate. However, over the life of the loan, customers would have to frequently remortgage to secure the best rates available to improve on an offset mortgage. The key is that many customers will, at some stage of their mortgage term, have a current account and a savings account.
We would suggest that customers who expect their savings to grow to around 20% of their mortgage would typically pay less in interest over the life of the loan than a conventional mortgage. Customers who are less active in changing their mortgage would be hard pressed to improve on an offset product.
The beauty of this type of mortgage is that it does all the work for you, as it is fully integrated. It ensures all your client’s savings and current account balances are working to reduce the mortgage term and interest charged.
Current account and offset mortgages provide other benefits too. Most come with a line of credit facility or reserve account which allows the customer easy access to the equity in their home and can be used for any purpose. Customers have immediate access to their reserve account with no need for additional forms, which means customers have instant access to additional funds at mortgage rates. So which customers will this appeal to? Certainly the 2.6 million mortgage holders who have a credit card and 44% of young families who have personal loans.
Where customers make use of the reserve facility they can repay it as and when they want to, provided they remain within their overall credit limit. Alternatively, customers can create their own named loan ‘pots’ and repay all or part of the loan over a fixed period.
Customers’ preferences have also had a significant impact on the development of flexible mortgages. While price remains a key element in overall mortgage choice, 40% of customers cite the availability of flexible features as an important feature in making their choice of mortgage and lender. Just three years ago, flexible mortgages accounted for 2% of the gross market market. Today, it is believed to be approaching 20%.
The next level of innovation has now been delivered which will allow third parties to offset their savings against a borrower’s mortgage, thus widening the scope and appeal of this new mortgage solution.
Current account or offset mortgages have seen a dramatic development and are no longer a niche product, but a mainstream option. Set against a background of a low interest rate environment. the effective rate of return and tax efficiency of offsetting is becoming a more important feature. As customers continue to demand greater flexibility and integration the offset mortgage will continue to grow in popularity.
40% of borrowers cite flexibility as an important feature when choosing their mortgage.
Clients with high savings in low interest or taxable accounts and those with high balances in their current account will benefit most from an offset facility.
Current account and offset mortgages allow clients to access equity in their home, creating a cost-effective alternative to loans and credit cards.