Offset Mortgage (with substantial cash) versus Investing

Perelandra

TCA wrote: »

I've been messing around with offset mortgage calculators but can't get my head round how they work out the results. e.g:

http://www.thisismoney.co.uk/money/mortgageshome/article-2034571/Offset-mortgage-calculator.html

Say borrow £120,000 (but fully offsetting with £120,000 cash savings) over 25 years (300 months). Interest rate 5%.

Using the calculator I get results as follows:

You could save an average £301.51 on your monthly repayments and still have access to your savings.

Estimated monthly repayment:£701.51
Reduced monthly payment with Offset:£201.51

I calculate that paying no interest on £120,000 over 300 months equates to a straight £400 per month. This above calculates the normal repayment as £701.51 and says at the top I can save £301.51 per month, which brings me back to my £400. All good.

So what's £201.51?

Offset mortgages are mysterious beasts...

If you were to save £201.51 in an account earning 5% interest, then over 300 months it would be valued at £120,000. So provided that you aren't paying any interest (fully offset), you could pay back the principal sum with monthly payments of just £201.51.

If you don't offset the mortgage, you need to make monthly payments of the £701.51 to have paid it off over the term.

The difference between the £201.51 and £301.51 is the effect of the reducing "theoretical" interest over time, as the mortgage is being repaid.

Thrugelmir

TCA wrote: »

Not sure of your point here. My theory was about "fully" offsetting the mortgage with cash and effectively not paying interest at all.

My question would be why would anybody want to do this. Incur fees to set up a facility that gives no benefit. Then have the hassle of juggling the account balances every month to ensure that the offset balance does not exceed the mortgage balance. Besides which the normal monthly repayments still have to be made to the mortgage account.

Surely far easier to have no mortgage. Then use one's disposable income to invest. Using valuable time to research investments and markets.

racing_blue

Thrugelmir, I think that too

The only answer I can come up with is that it is a gamble - pay fee X, fix rate, hope things change & the advance can be invested to return more than X

AlwaysLearnin

It doesn't have to be that difficult, per previous posts.

Fees are minimal (in OP's case as a first time buyer, potentially no mortgage or survey fee, plus £1k cashback, so might even pay to do). It can be set up so mortgage payments are taken from the offset savings, so no need for any juggling.

The benefit is that you still have access to the funds should you ever need them, at mortgage rates, which might be more preferable than having to cash in investments/ISA's/fixed rates etc (even if only short term), whereas if you've paid the mortgage the money is gone. Maybe you never need to use it, but it provides the option if you ever did.

The company I work for (a multi national) pays a significant amount of money to have a revolving credit facility available to it should it ever need funds. This allows a similar facility at a domestic level for little or no cost.

Per previous debate, it may be more beneficial to invest the funds instead. However, as with most things, it's personal choice. This works for some (of which I was one)

TCA

Perelandra wrote: »

The difference between the £201.51 and £301.51 is the effect of the reducing "theoretical" interest over time, as the mortgage is being repaid.

I was with you until this bit. I now see that £201.51 compounded monthly at 5% equates to £120k. Thanks. A bit of a meaningless figure is it not? Especially given the offset savings account pays no interest. If I could earn 5% elsewhere I wouldn't be bothering offsetting.

The £100 difference between the £201.51 and £301.51 did get me wondering if this was 20% tax on my net £400 payment.

Am I correct in saying in this example that £400 per month is the actual payment required to clear the £120k when it's fully offset? If so, I'm baffled as to why it's not shown.

TCA

racing_blue wrote: »

Thrugelmir, I think that too. The only answer I can come up with is that it is a gamble - pay fee X, fix rate, hope things change & the advance can be invested to return more than X

Forget about investing the advance/your cash offset. That's an option but it's a step further than you need go. Look at the example from the calculator above. On a 5% mortgage, you'd save over £300 per month in interest in being fully offset. That's over £90k in interest you don't have to pay over 25 years, plus you have access to your cash in case of emergency. The mortgage interest rate is therefore effectively the rate you're earning and with no gambling in the stock market. And it's a net rate!

TCA

Thrugelmir wrote: »

Surely far easier to have no mortgage. Then use one's disposable income to invest. Using valuable time to research investments and markets.

As AlwaysLearnin explained above, the mechanics of an offset mortgage needn't be complicated or cumbersome. Re your last point of easier having no mortgage, if you had the choice, wouldn't you rather pay off a loan over time with no penalties or interest, rather than pay it off in one go?

racing_blue

TCA wrote: »

On a 5% mortgage, you'd save over £300 per month in interest in being fully offset.

Maybe I'm being obtuse, but still I'm not with you!

The mortgage rate could be 1%, 5%, 105%, whatever. If you were fully offset, the interest payable would be same. Zero.

Which of course, is the same amount of interest you pay if you just buy the house outright with the cash that you have. Zero.

TCA wrote: »

That's over £90k in interest you don't have to pay over 25 years

Well, yes- because you are effectively borrowing zero. You are really only taking an option to borrow. (Alwayslearnin thinks you may even be able to get paid for this, which I find astonishing if true, because in every other situation I can think of it costs money to make a one way bet)

TCA wrote: »

plus you have access to your cash in case of emergency.

NOW you start to pay interest...

TCA wrote: »

The mortgage interest rate is therefore effectively the rate you're earning and with no gambling in the stock market. And it's a net rate!

I don't really get this. Earning how?

What I can see, is that if you have an option to borrow at rate A and to save at rate B, you may profit if B exceeds A.

To turn a profit, the net (rather than gross) saving interest has to exceed your mortgage rate.

I believe this could well happen in the next few years and is what attracted me to this debate btw

Perelandra

TCA wrote: »

I was with you until this bit. I now see that £201.51 compounded monthly at 5% equates to £120k. Thanks. A bit of a meaningless figure is it not? Especially given the offset savings account pays no interest. If I could earn 5% elsewhere I wouldn't be bothering offsetting.

The £100 difference between the £201.51 and £301.51 did get me wondering if this was 20% tax on my net £400 payment.

Am I correct in saying in this example that £400 per month is the actual payment required to clear the £120k when it's fully offset? If so, I'm baffled as to why it's not shown.

Sorry, I wasn't quite clear last night;

Yes, it's a meaningless figure, since it's assuming that the mortgage pas the same interest rate if you're in debit or credit (which clearly they don't, or there'd be a lot of demand for offset mortgages with high interest rates ); but that's the way the calculators are working.

If your offset mortgage pays zero interest on "credit" balances, then yes it would be £400/month. In practice, if the mortgage were fully offset, you could better this by putting that £400 into an interest earning account. (In this situation, you're no better off than if you hadn't taken the mortgage out, and just put the money into a savings account).

I think racing blue puts it well above, by the way, when he says that you are really taking out an option to borrow, and in a very flexible way. That's the benefit of what you're proposing here- you can, once it's set up, borrow up to the value of the offset immediately, at a secured-loan rate of interest. This is how I personally would look at the benefit of the offset mortgage, rather than trying to think in terms of interest saved.

If you look at this through the "interest saved" lense, then you might be able to convince yourself that the higher the mortgage rate you signed up to, the greater the interest you were saving... and that's clearly daft.

Perelandra

racing_blue wrote: »

What I can see, is that if you have an option to borrow at rate A and to save at rate B, you may profit if B exceeds A.

To turn a profit, the net (rather than gross) saving interest has to exceed your mortgage rate.

I believe this could well happen in the next few years and is what attracted me to this debate btw

If you get a good fixed rate, then yes this may be possible, but I think it's unlikely if you get a tracker rate:

I downloaded some data on historic savings rates from here:

http://www.swanlowpark.co.uk/savingsinterestannual.jsp

And the historic base rates from here:

http://www.swanlowpark.co.uk/savingsinterestannual.jsp

And then charted them:

http://www.freeimagehosting.net/3ux5b

Not surprisingly, the gross rates you'd need, based on a tracker + 2.79%, have never been available. Interestingly, it looks like it's only been VERY recently that savings rates have exceeded the BOE rate (does that seem right?)