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  • 18/05/2009
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David Finlay, intermediary business director at Woolwich, gives an account of the pros and cons of offset mortgages, in the first of a series of articles

As a naturally competitive industry, it is accepted that players within the market will continue to look for the next ‘big thing’ in terms of products, sectors, services and technology. As a result, innovation has become a little stifled, but this does not mean that there are insufficient tools for intermediaries to use. Sometimes, a product that has always served a purpose can rise to the surface and become increasingly applicable to a much wider audience, because of current market and economic conditions. A prime example of such a product is the offset mortgage.

With the Bank of England base rate currently residing at unparalleled lows and being forecast to remain at this level for some time, some borrowers and savers are experiencing their own highs and lows dependent upon their situations and indeed the type of mortgage deal they are sitting on.

There have been many stories, especially in the national press, about consumers on low base rate trackers who are now quids-in (or just paying a quid out in some cases) on their repayments, and have cash to spare each month because of these record interest rate lows. This raises the issue of what to do with this extra cash, especially when savings rates are also residing at low levels without even taking into the account the tax being charged on the interest. Undoubtedly, this could cause a dilemma between saving and overpaying, and this is an area that we will look into in more depth in a later installment in this series of articles.

It is useful to construct a picture of the offset market and how it has evolved. Pioneered in Australia in the early 1990s, the offset mortgage has only been in the UK since the Woolwich became the first high-street lender to launch the concept in 2000. Although starting out as a niche product, Datamonitor made the prediction a few years ago that by 2009, the offset and current account mortgage market would account for 30% of total mortgage lending. Hindsight is a wonderful thing, and looking back, this figure was somewhat ambitious. While the concept and the flexibility of the product are highly regarded by some, offset has still to be fully embraced by brokers.

There is no doubt that since the first few years of the product’s launch, its popularity has grown and increasing numbers of borrowers are thinking holistically about their financial situation and the long-term value of particular mortgage products. It is also fair to say that borrowers are steadily becoming more aware of the cost of borrowing, and have become better educated about how best to manage their finances and keep the potential costs of interest rate exposure down.

But again, we hark back to the point that the potential of the market – as illustrated in Datamonitor’s ambitious prediction – has not come to fruition. There are a number of reasons for this, including pricing issues, lack of understanding and a lack of competition. Some brokers may have also viewed offset with some scepticism, as it restricted their ability to generate valuable remortgage business.

However, perhaps the biggest obstacle remains the perception of the product. Traditionally, offset mortgages were considered only suitable for those with larger balances to deposit – specifically those with irregular incomes or tax bills to pay where saving levels could be substantial. Historically, the pricing reflected the type of customer which the product targeted and the associated flexibility these products offered. This made the benefits unappealing to more typical borrowers. In time, through increased competition and innovation, the market has become far more sophisticated, and premiums have been lowered to make offset more mainstream.

Put in simple terms, an offset deal combines mortgages and savings in a single account, allowing the mortgage to be offset by a credit balance, which can reduce the overall interest charged. The principle is simple – most mortgage borrowers also have savings, even if they are small, and using this money to cancel out mortgage debt makes perfect sense in a variety of scenarios. Savers avoid paying tax on interest that their deposits would otherwise have earned. And because offset mortgage lenders calculate interest daily, every pound on deposit works hard to reduce the cost of borrowing.

This can make it applicable for first-time buyers through to professional portfolio landlords; from new families looking to remortgage to home owners simply looking to pay their mortgage off before retirement by drastically reducing the mortgage term. These are all areas that we will investigate in more detail later in the series, as in terms of understanding and using offset, it is important to be fully aware of the applicable circumstances where it can be appropriate.

Looking briefly at the current market, there is evidence that borrowers and intermediaries are increasingly waking up to the benefits of offset mortgages. Indeed, 2008 saw a record number of Woolwich borrowers taking out offset mortgages, a jump of 19% compared to the previous year.

The momentum has continued this year, with a quarter of borrowers opting for offset over other mortgage options in February – the highest percentage since Woolwich pioneered the mortgages in 2000. These statistics make interesting reading and the obvious question is: why? n

In part two, David Finlay will look at the role that interest rates play in the resurgence of offset

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