Offset Mortgages -- the Numbers

System

Thank you for your advice. Much appreciated.

david78

I'll repeat DiggingOut's excellent formula with a bit of notation.

B = mortgage balance
S = savings balance

OR = offset rate
NOR = non-offset rate
SR = savings rate

Then an offset is better value (cheaper) if

S > (OR-NOR)/(OR-SR) * B

e.g. if (OR-NOR) = 1% and (OR-SR) = 3% Then you get

S > 1/3 * B

so the offset route is better if you have more than 1/3 of your mortgage balance as savings.

But, it occurs to me though that B is not constant for a repayment mortgage so it should be replaced by an average value over the mortgage term. Because B ends at 0, a good number for the average is B/2.

So the longer-term formulae is:

S > (OR-NOR)/(OR-SR) * B/2

Or in my example.

S > 1/6 * B

Also if you have scope to increase Savings S over the years, the offset becomes more attractive. They also become more attractive towards the end of your mortage term when (a) B is decreasing faster, and (b) the fees on remorgages become relatively more expensive. Anyone like to modify DiggingOut's formulae to account for these factors?

Joe_Bloggs

@david78 SR is effective savings rate after tax.
Well done with your thought provoking illustration.
J_B

showmethemoney_6

Digging out - this is great. Its just what I needed as I have to make a decision today on a morgage.

However, I am confused as to how your formula works (yes I'm thick :-[).

Can you tell me what numbers I should be plugging in where?

The current rates I have at the moment are;

off set rate 5.85%
non off set rate 4.89%
current account rate 4.85%
savings rate (after tax) 2.91%


I'm planning on taking a £40k morgage. My savings to morgage percentage is arounds 55%. I am a high rate tax payer.

Is it better to get a offset morgage?

Do you need more info?

Any help would be gratefully received.

Thanks for your help ....

Joe_Bloggs

From your effective interest rate after tax I take it you are a high rate tax payer.
if your mortgage is £40000 then your savings are £22000 given the 55% ratio you mentioned.

The interest per year for your normal 4.85% mortgage will be 4.85*40000/100 = 1940. You get interest back from savings 2.91*22000 = 640 . So the net interest paid per year is 1940-640 = £1300.

Now the offset case.
Interest 5.85 * (40000 -22000)/100 = £1053.

The offset wins by 1300 - 1053 =£247 per year.


Placing £3000 of the 22000 in a cash ISA and getting 5% tax free will reduce the interest paid in the non offset case to £1237 from £1300.

The offset wins by 1237-1053 = £184 per year.


The two values of interest paid become equal from the seperate mortgage cases when you have £13000 of savings. This value is £1570 of interest per year.

J_B.

showmethemoney_6

Thanks J_B thats great.

One question though,

The 22k savings will be built up during the year, so for simpliciy we can say I will save approx £1800 per month.

Does it still work in that scenario?

Thanks for your help - much appreciated.

DiggingOut

X is the breakeven point, basic formula:
X = 100 * (OffsetRate-NonoffsetRate) / (OffsetRate – SavingsRate)

using your numbers:
X = 100 * (5.85-4.89) / (5.85 – 2.91)
= 100 * (0.96) / (2.94)
= 32.65%

If you have a higher savings percentage than 32.65%, an offset is to your advantage.

Note, you didn't say what your average current account balance is, so I did not include that. I also question a current account rate of 4.85% after tax, I suspect that is a before tax rate.

So given that you have 55% savings, even without the current account, it sounds like offset is the way to go.

But before you assume an offset is best, are you certain about that savings rate? I make that out to be 4.85% gross, and you can do quite a bit better. For instance, 5.5% with cahoot would give you an after tax rate of 3.3%, which changes the breakeven point to 37%.

If you are married and your spouse is a basic rate taxpayer, the savings can be put in her/his name, and the aftertax savings rate becomes 4.4%, which means you have to have more than 66% in savings to break even.

If your spouse is not a taxpayer at all, the after tax interest received on a cahoot savings account is greater than the mortgage interest you have with the non-offset mortgage, so you are well ahead with the non-offset mortgage in that case.

Again, none of those scenarios reflects the benefit of having your current account offsetting your mortgage. This will be beneficial, but unless your current account balance averages £5K or more it is unlikely to have much of an impact on the numbers.

DiggingOut

Thanks J_B thats great.

One question though,

The 22k savings will be built up during the year, so for simpliciy we can say I will save approx £1800 per month.

Does it still work in that scenario?

Thanks for your help - much appreciated.

Sorry, crossposted, so didn't see this. What do you mean, exactly? You don't have any savings now but will save that much a month so by the end of the year will have 22K?

Joe_Bloggs

@showmethemoney
Have you considered a two year term fixed rate discount deal. If you can save at 1800 a month then you can pay your mortgage in two years.

Edit point:

You can boost your savings in the short term by aquiring 0% interest credit cards and balance transfering the credit limits into the tax free offset current account.

You can always do this trick with other savings products in the case of a non offset mortgage. The benefits are less if you pay tax on interest as Dug says.

DiggingOut

I had similar thoughts, J_B. If the savings now are nil but are going to go up by £1.8K a month, I would look at the lowest interest rate possible.

The only thing is, I wouldn't get a fixed rate. I would want a very low 2 year discount with no tie-ins beyond the 2 years, and set up the term of the mortgage for repayment basis for 5 years (shorter if they'll allow it). That way, your mortgage balance will be decreasing, and even if rates go up they won't hurt that badly because interest will be charged on such a low amount.

Your payments will be quite a bit higher, of course, but that is because you will be paying the principal down, and the remaining money can be saved to pay it off entirely at the end of two years.