Offset Vs Fixed

renton_sickboy

Hi all,
first every post, long time reader. Brilliant site.

Recently came across the Offset mortgage idea (I know, what kept me ) and thought it sounded fantatsic until I read Martin's Mortgage Guide that explained that it might not be. He did mention that Offset mortgages have higher interest rates that fixed (in general) and that if you just want an overpaying option then you should just go fixed with the overpaying option. He also said that if you had a lot of saving/current account money, something like £25k, then the Offset might be better.

So my question is, for ease of calculation, assume £100k mortgage 25 years.
Fixed mortgage rate 5.25%, Offset 5.5%, lets also assume there are no interest rate changes, how much do I need to have in my savings/current acc to offset that extra 0.25% over the fixed mortgage rate. Bonus points awarded for showing how you reached this figure

thanks
R_S

godsakes

there's a 0.25% difference which equals £250 more interest with the offset option.

to make up that difference you need around £4,762 in the offset

renton_sickboy

godsakes wrote:

there's a 0.25% difference which equals £250 more interest with the offset option.

to make up that difference you need around £4,762 in the offset

Thanks for that godsakes, can you give me a formula so I can stick in different rates and different amounts. Does the term length make a difference 20 years vs 25 years?

While I've got you here, on a similar theme, if I'm in a fixed mortgage thats tied in for 2 years and in the period they charge 3% for making overpayments, is it still a good idea to make overpayments or does the 3% fee negate the benefit.

Thanks
R_S

godsakes

renton_sickboy wrote:

Thanks for that godsakes, can you give me a formula so I can stick in different rates and different amounts. Does the term length make a difference 20 years vs 25 years?

While I've got you here, on a similar theme, if I'm in a fixed mortgage thats tied in for 2 years and in the period they charge 3% for making overpayments, is it still a good idea to make overpayments or does the 3% fee negate the benefit.

If all you're trying to do is weigh up a cheaper fixed rate deal vs a more expensive offset... then all you have to do is to look at how much extra you're paying for the offset

for example if the offset was 0.5% more expensive....

% difference x mortgage = interest difference
0.005 x £100,000 = £500 (more interest you're paying)

interest difference / offset % = amount needed to offset
£500 / 0.055 = £9090.91

re the fee if they're charging you 3% for overpayments - you'd be better off sticking it in a high interest account (if you'r mortgage is 5% you'd only be saving 2% after the fee so just stick it in a account which pays at least 4%)

bunking_off

Maybe I'm being dumb but I think you're over-simplifying things.

Consider the two scenarios for your "equilibrium" situation of £100k mortgage and £9090 in "savings".


Approach 1 : offset
Interest = 0.055 x (100k - 9090) = £5000/yr

Approach 2 : discount
Interest paid = 0.050 x 100k = £5000/yr
BUT there are the savings of £9090, which will accrue interest...say 3.5% net for sake of argument, = £320/yr
so net interest paid = £4680/yr.

....ie not in equilibrium so £9090 savings isn't the point at which the two approaches balance. To work out the "cost" of the overhead of an offset, you need to take account of what rates your savings would get elsewhere.

Of course, 99 times out of 100 the best rate your savings will get is to use them to overpay your mortgage. However, if you do that on a fixed rate, the funds are sunk and you can't get at them again, versus with an offset or current account mortgage they're still readily accessible. As such, a direct financial comparison isn't possible, as you need to factor in how much you value the flexibility to overpay then reborrow (in the extreme, with a current account mortage you're continually doing this as you pay your mortgage down when you get your salary at the beginning of the month then gradually extend your mortgage as you spend over the month).

godsakes

bunking_off wrote:

Maybe I'm being dumb but I think you're over-simplifying things.

well to an extent - yes you are right that the £9k could be earning interest elsewhere in the fixed mortgage scenerio

but the purpose was to illustrate how much it took in the offset to counterbalance it's extra rate.

but how complex do you want it?

do we factor in the fact that after 2yr the fixed rate deal reverts to 1% above base rate and has exit pentalies etc whereas the offset tracks at 0.25% above base rate for the life time of the mortgage .

bunking_off

godsakes wrote:

do we factor in the fact that after 2yr the fixed rate deal reverts to 1% above base rate and has exit pentalies etc whereas the offset tracks at 0.25% above base rate for the life time of the mortgage .

True, and not forgetting that to remortgage involves paying arrangement fees/closure fees. Which is why I use a current account mortgage myself...

blisteringblue

I have to say Bunking_Off is the man if you want to know how to make the most out of your one account. I've not seen a post he's not talking sense.

PS. bunking, thanks for that PM advice, been trying to thank you but your message box is full.

I've just got my formal offer re my one account, a bit annoyed my valuation was 13k less than I thought which put me into the next rate bracket, but just rang them up to reduce my facility and take it back down. Can't fault their service so far.

I know it's a higher rate, but it is the flexibility I want (currently with an abbey flexible mortgage where I overpay). In the next few years I have twins going to Uni :eek: and I will be hammering the account to get it paid off, but I just know I'm going to need access to it for their Uni costs.

Plus, my wife is being made redundant this year after 20 years. Its a large payoff (over 25% of mortgage) and the one account is the perfect vehicle for this. It's reduced our interest instantly, and we can still use it while my wife retrains. I couldn't do this with the Abbey Flexible Mortgage, they have tried to sell me the Flexible Plus, but it's still not as simple and flexible as the one account.