Having welcomed the concept of flexible mortgages, the UK mortgage market is now similarly starting to embrace the concept of offsetting savings against borrowing to reduce interest costs and so reducing the term of a mortgage. In its simplest form, this would be a deposit account with short-term savings linked to a mortgage, but can also mean a full current account offering where any surplus funds are also offset against the mortgage on a monthly basis.
Since 2000, the current account mortgage market and the simple offset mortgage market have grown to just under £30 billion as at the end of 2004. Some commentators predict this growing segment of the market will account for 20 per cent of new business within the next five years.
Growth
So what’s fuelling the 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 increasingly important for financially astute borrowers and advisers to consider products in this area. At a time when returns from the stock market and short-term savings markets have been relatively poor the offset mortgage market has also brought to our attention a way to use our savings in a tax efficient way. This is because the savings funds are netted against the mortgage balance and interest is only calculated on the difference. No credit interest is actually received and therefore no tax is payable.
This however, is not the whole story. Even just 18 months ago, there was generally a premium to be paid for an offset-type mortgage, whether this was the simple, linked savings account or the full current account offering. The general rule of thumb was that a customer needed to have a minimum of £20,000 in savings that they could offset against their mortgage. The interest savings this would lead to seemed to compensate for the higher interest rate or fees which went alongside these products.
What we are seeing now really turns this on its head. Pricing on offset type products has come down significantly in the past 12-18 months as the market grows in competitive terms. We are now actually seeing pricing which is not far off mainstream and some lenders do not load rates at all when offering offset as a product feature. What this means is that instead of it being a product that only makes sense for those with a lump sum to offset, it can be considered for those who may not have large savings at the moment but would like to save £100 or £200 per month. Nowhere is it more appropriate than for the self-employed, who require to pay tax bills once or twice a year. Applicants simply put money away on a monthly basis, which is offset against their mortgage, cleared out when needed then started again.
Long-term benefits
We recently carried out an exercise to work out the long-term benefits of offset by comparing the cost of a mortgage over 25 years for someone with offset, paying £100 into an offset account and someone who remortgaged every two years and paid the associated fees for exiting and entering new deals. It may be surprising but the applicant with the offset mortgage was actually better off at the end of the term. So, while it may not be right for everyone, for those looking for a long-term, good value deal, it should definitely be considered, whether an immediate lump sum can be used for offset purposes or not.
Over the next few years, my feeling is that we will see a continuation of this competitiveness in pricing, which means these types of products will become more accessible to all mortgage customers rather than simply the more financially well off.
Product innovation
Product innovation will also continue to drive the market forward. Already we have a great variety of product features available such as the usual trackers and discounts, alongside current accounts and deposit accounts. However, according to Council of Mortgage Lenders (CML) figures about 65 per cent of new mortgage business is still written on fixed rates. This means that offset is only really applicable to 35 per cent of the market at best. However, recently we have seen the introduction of full offset type products against some short-term fixed rates. This is typically against one or two-year rates but as this is what the majority of borrowers still seem to be inclined to look for it again opens the offset market up to them without taking away the certainty of fixing their monthly payments over the short-term. The availability of this type of product is still small but it looks to me like this will be the next area of product innovation over the next couple of years.
I am absolutely certain that the awareness of these types of products will continue to grow among consumers and it is vital the well-informed adviser understands the market fully and not simply write them off as only being suitable for wealthier, financially astute clients and considers them alongside more mainstream mortgages for those with the ability and willingness to start saving. Offset mortgages are definitely suitable for those with higher savings balances but should not be ruled out just because someone does not have £20,000 in savings they can use for this purpose. The choice of product and pricing should make this a key area for consideration.
The market is still evolving but there have been significant developments over the past 18 months, both in terms of product development and pricing and I think this will continue apace and make these types of products suitable for a much broader section of your client base. If an adviser can demonstrate to a customer the long-term savings available and the fact they can add further value to the client relationship it should have long-term benefits for all.
