Offset Mortgage (with substantial cash) versus Investing

TCA

I'm not a house owner but as a long term renter I'm always interested in the housing market, house prices and the seemingly consistent UK government attempts to prolong high property prices and continue lending more to those that cannot afford to pay it back. I think I'd like to be a home owner but still think property is way over-priced at the moment and needs some sort of correction downwards. Not sure it'll ever happen though.

Anyway, as someone with healthy cash balances (who is drip-feeding them monthly into unit trusts), my mind still wanders to property purchase and the arguments for and against paying out "wasted money" on rent. Also, with some fixed term cash deposit lump sums maturing in the next couple of years, I'll need to find somewhere for them and savings accounts will no longer cut it given the poor rates, so it looks like the stock market or something else......

My attention was drawn yesterday to a new offset mortgage from Yorkshire Building Society - 4.10% fixed for 10 years with no fees - and I got my calculator out and did some googling on offset mortgages, not having read much about them before. Let's take an example:


Property purchase : £160,000
Offset Mortgage 75% LTV 10 years : £120,000
Cash savings for offset : £120,000


So assuming I'm financially well-off (big assumption granted) and able to continue my monthly passive investing drip-feeding into my unit trusts, feed and clothe my family and can actually make the mortgage payments etc.... what are people's views on holding cash savings to offset an equivalent mortgage and thereby (if my thinking is correct?) effectively borrowing free of charge?

I'd pay back over 10 years which I'd presume to be the minimal length of mortgage. I've read nothing to say that this would have to be over 25 years. I presume the monthly mortgage payment would be set based on the loan amount and interest rate, irrespective of cash offset savings, and so if I held cash equivalent to the initial mortgage for the full period, I'd pay back the loan in about 8 years or so (possible early redemption fees of a couple of percent).

I'd still have full access to the cash if required and would save (in this case), mortgage interest at 4.10%. Obviously I'm not earning interest on my cash balance but also I'm not taxed on anything either, thereby freeing up more taxable income. Especially useful for higher-rate tax payers, which I may or may not be.

OK, potentially I could earn more by lumping money into the stock market (or lose more) but this has got me thinking, regardless of how overpriced I think the current housing market is.

Any thoughts on this? Am I missing something glaringly obvious? Interested to hear some different views.

notanewuser

It's exactly what we did in 2008. Mortgage is fully offset, house will be paid off within the 10 year fix and we're not paying tax on pathetic savings interest levels.

kidmugsy

You either rent a house or you rent the money to buy a house.

The belief that renting the money is bound to be better is just a quasi-religious belief that house prices must always increase, whereas history shows that they always do until they don't.

TCA

notanewuser wrote: »

It's exactly what we did in 2008. Mortgage is fully offset, house will be paid off within the 10 year fix and we're not paying tax on pathetic savings interest levels.

Thanks for the reply. So the mortgage term is 10 years? Or have you got a longer term with only the fix for 10 years? Are you looking at redemption fees?

notanewuser

TCA wrote: »

Thanks for the reply. So the mortgage term is 10 years? Or have you got a longer term with only the fix for 10 years? Are you looking at redemption fees?

It's a 20 year mortgage with a 10 year fix. We always planned to pay it off within the 10 years, but if for any reason we can't, it won't make a difference.

There are redemption penalties within the 10 years, but they aren't that massive past 5 years. We're not planning to move or change anything so that doesn't really matter.

TCA

kidmugsy wrote: »

You either rent a house or you rent the money to buy a house.

Yes, but also in my example, I'm proposing to have the cash to buy a house outright.

That could obviously be done at year 0 and the argument could be a straight "buying versus renting" proposition, but borrowing effectively free of charge and having access to that cash savings offset account has more appeal.

I wouldn't consider a house I lived in to be an investment but the alternative home for these future funds would be stock market investments. And given I have to live somewhere in retirement, I either have rent to pay (from my investments) or I own my own home and have no rent to pay. So a solution is required either way.

An offset mortgage with full cash offset seems an interesting option if affordable.

AlwaysLearnin

There's no hurry to pay it off. If fully offset, YBS offer the option to pay the mortgage payments from the offset account without reducing the term. This means that the mortgage and savings balances reduce in line with each other for whatever term you chose. The longer the term, the more time you have the offset savings (albeit reducing balance) available should you ever need them - more flexibility than giving it to the bank by paying off quicker:

http://www.ybs.co.uk/documents/mortgages/YBM3752_OffsetOption.pdf

TCA

Thanks AlwaysLearnin. My thinking was wrongly restricted to the fix period but of course if fully offsetting the mortgage with cash savings then the interest rate doesn't matter as you wouldn't be paying any. So as you pointed out, no rush to pay it off. A longer term means lower (largely fixed) monthly payments, which would presumably be a good thing if inflation increases.

AlwaysLearnin

Mortgage payments would remain a fixed amount as long as the offset amount remained the same as the mortgage balance. I believe that as part of the application process you tell them how much you will put in the offset savings and they work out a provisional payment amount on that basis, which in the case in question would effectively be at 0% because of the full offset. Pay the mortgage out of the savings and select the relevant option from the previous link, and it essentially takes care of itself - you can basically forget it unless you ever need it.

Inflation isn't really an issue, as any effect it has on the mortgage it would have an equal and opposite effect on the offset savings. The benefit is having access to the money longer if you needed it.

Edit: another benefit is that you need never to bother yourself with rate chasing when fixed/discounted/capped rates etc come to an end, nor have to pay related arrangement/survey fees etc that are part of that process, as rate changes are irrelevant

TCA

Yes, agreed regarding inflation and the savings impact. I meant more that you'd be taking on a fixed debt at current prices with fixed repayments over the term, so neither rising prices nor interest rates would have an effect.

Does anyone know if the lending criteria is any different for an offset mortgage when depositing substantial savings? I presume not given you could empty your offset savings account at any time but would still be liable for the mortgage payments.

Perelandra

My own situation isn't too dissimilar from the one that you may go for-

I drip feed money into my ISA, SIPP. pension and employer share schemes each month. In addition, I have a First Direct Interest only offset mortgage, against which I pay the interest each month, and also increase the offset savings (effectively paying off some of the principle sum, but retaining easy access to it).

I have things set up this way, as my monthly investments are relatively high risk (mostly equity funds/trackers), so I regard the savings I build up each month to reduce the overall risk- I am building these up at a significantly faster rate than I need to, to have the mortgage fully offset before the end of the term.

There may come a situation where I want to take those surplus offset savings and put them into investments- for example, if there's a stock market crash. The offset account gives me great flexibility that I wouldn't necessarily have f I had the savings in fixed-term deposits, or a conventional mortgage.

Overall, I think that the cost of the mortgage (interest paid, plus interest on equity in home/savings foregone, plus maintenance) is lower than the cost of renting would be.