Offset Mortgage - Do I reduce the Term or Reduce the Payments?

Kirstinmc

Hi All,
I've just changed my mortgage to an Interest only one with an offset account. We used the calculator to work out that with our savings in the offset, this would be the most beneficial. I am confused at which option to chose with using the money in the offset for: do I choose to reduce the payments or reduce the term? What happens if I then take the money out of the offset account again, does this increase the term again? If this is the case then I would rather reduce the payments.

Thrugelmir

What's your plan to settle the debt at the end of the mortgage? Interest earnt on the offset account will be used to reduce the debt owed. Without any other action they'll still be a balance to settle.

AnotherJoe

Kirstinmc wrote: »

Hi All,
I've just changed my mortgage to an Interest only one with an offset account. We used the calculator to work out that with our savings in the offset, this would be the most beneficial. I am confused at which option to chose with using the money in the offset for: do I choose to reduce the payments or reduce the term? What happens if I then take the money out of the offset account again, does this increase the term again? If this is the case then I would rather reduce the payments.

It doesn't quite work that way, or at least, it didn't with mine.(Barclays/Woolwich)

Lets say your mortgage is £100k and you have £20k in your bank account. (there was no specific "offset" account it was all pooled together)

That means, instead of them paying you a (derisory) rate of interest on the £20k in your bank account, and charging you interest on £100k, they charge you interest on £80k instead.

With my bank that meant that instead of the monthly payment being, say £300 it might be £280. If you pay by direct debit they then will most likely reduce your "normal" monthly £300 payment to £280.

To counteract that, I then set up a standing order to pay the £20 savings (actually far more than that) to pay off the mortgage principal as well.

Should you decide to spend £10k of your money on say a car, then next month the reduction will be less as there is interest to pay on £90k not £80k.

In the long term as long as you overpay to make up the lowered payment its irrelevant if its reducing the principal or the term, it all works out the same in the end.

With an interest only mortgage you "should" be overpaying anyway, unless you have another plan to pay off the money when the term ends or its a BTL?

getmore4less

The reality is it does not matter which you do in terms of total cost.

It can effect the practical situation if not careful.

Check what the lender means by reduce term.
Often this is not the real contractual term but just their way of saying keep the payment the same(which just means overpay the difference to what the reduced payment would be.

If your contractual payment is based on interest only you need to plan the repayment strategy, two main options are overpay or ensure the offset ballance never goes below a repayment curve(or combination of both).

at any given point in time you want to be sure that the cash and future payments to the mortgage/offset will get you to zero before the end of contractual term(dead easy with a simple mortgage calculator).

Which calculator did you use to decide the offset is cheaper? some get the answers very wrong.

getmore4less

Thrugelmir wrote: »

What's your plan to settle the debt at the end of the mortgage? Interest earnt on the offset account will be used to reduce the debt owed. Without any other action they'll still be a balance to settle.

offsets should not work like that as that interest would be taxable.

They should all work by charging interest on the net debt.

getmore4less

Barclays/Woolwich have the options to reduce payment, keep the payment the same and never reduce the payment even if it would go down for another reason like a rate drop.

mvteng

We have our Offset mortgage with the Clydesdale.


With ours every month our payment is fixed & doesn't change.


But every month our mortgage total comes down by the amount of extra interest.


so something like this :


Mortgage starts at £100k
Savings = £25k


Monthly fixed payment = £350
Monthly Interest on £75k = £75


so every month my mortgage total reduces by £275


so effectively mortgage will be paid off earlier


Hope this makes sense, but understand I've maybe not explained it too well

Thrugelmir

mvteng wrote: »

Hope this makes sense, but understand I've maybe not explained it too well

OP has an interest only mortgage not a repayment.

AnotherJoe

Thrugelmir wrote: »

What's your plan to settle the debt at the end of the mortgage? Interest earned on the offset account will be used to reduce the debt owed. Without any other action they'll still be a balance to settle.

Normally you write such sensible things too But that is wholly wrong and needs to be corrected to avoid confusing the OP.

Money in bank account is notionally deducted from the outstanding mortgage.
Mortgage interest is charged on the difference.
No interest is paid on the amount in the account

Example, money in bank account £20k
Money owed on mortgage £100k
Interest is charged on £80k.
No interest is paid whatsoever on the £20k.

Whether its an IO mortgage or a repayment doesn't alter things AFAIK, but "obviously" if IO you need to make arrangements to be sure it will be paid off.

With Barclays at least this calculation is run daily.

Thrugelmir

AnotherJoe wrote: »

Normally you write such sensible things too But that is wholly wrong and needs to be corrected to avoid confusing the OP.

Money in bank account is notionally deducted from the outstanding mortgage.
Mortgage interest is charged on the difference.
No interest is paid on the amount in the account

That's how my offset mortgage worked with the HRBS.

Mortgage systems aren't built for complex calculations as you suggest. The majority of mortgage lenders only recalculate the interest (monthly payment) at a rate change. The interest is therefore calculated on £100k. Every month a notional credit for the interest earnt on the offset is deducted from the mortgage account.

getmore4less

Thrugelmir wrote: »

That's how my offset mortgage worked with the HRBS.

Mortgage systems aren't built for complex calculations as you suggest. The majority of mortgage lenders only recalculate the interest (monthly payment) at a rate change. The interest is therefore calculated on £100k. Every month a notional credit for the interest earnt on the offset is deducted from the mortgage account.

The monthly payment and interest are separate things.

Any daily interest mortgage needs to be calculating the interest daily.

if they are adding back interest they should be taxing it.