Is an offset best for my circumstances?

sink_or_swim

Is anyone better at working out these things than me? I’d really appreciate any advice.

We require a mortgage of £180000. Best rate we can find is 3.85% with no fee and £250 cashback.

We will have roughly £60000 left over once purchasing. We want to keep this aside in case we want to send our children to private school (suspected ADHD, secondary schools are awful here, etc). This would happen in 3 years time.

We should be able to save ~£2000 each month, but on top of that at any one time there is likely to be a lot more in our account (so for example we set aside so much each month for annual expenditures but for most of the year that money just sits in the account).

We also will be saving an additional £1000 per month to go into a pot for house improvements but this money could happily sit in the offset account.

I can’t figure out if we’d be better with an offset mortgage. The best rate we can find is 4.18% with a fee of £1000. We spoke to a broker who said we’d be thousands worse off each year with an offset, but my calculations suggest otherwise. We are both higher rate tax payers and every month I seem to get emails telling me my savings interest rate is reducing yet again. The calculator on here I just cannot understand.

Thanks

Brie

Well it sounds like you're talking about a mortgage of £180,250 at 3.85% versus £121,000 at 4.18% so my initial guess is you'd be better in the short term if you offset.  

The next bit that might affect this is what is the mortgage term?  If you have it set for 3 years then you can reconsider the situation when private school might start to require fees.  

Looking further -  £180,250 at 3.85% for 1 year is 6940 while £121,000 at 4.18% is 5058.  If you could get 4% on savings of £60k that would bring the cost of the first down to 4540.  That assumes you can maintain that rate which seems unlikely.  But offset you are saving on the mortgage interest rate of 4.18% so the more you save each month the better this will be.

Ultimately I don't see the difference being "thousands" like the broker is stating.  It's reasonably close call with the offset winning more as the rate on savings decreases.  

saajan_12

sink_or_swim said:

Is anyone better at working out these things than me? I’d really appreciate any advice.

We require a mortgage of £180000. Best rate we can find is 3.85% with no fee and £250 cashback.

We will have roughly £60000 left over once purchasing. We want to keep this aside in case we want to send our children to private school (suspected ADHD, secondary schools are awful here, etc). This would happen in 3 years time.

We should be able to save ~£2000 each month, but on top of that at any one time there is likely to be a lot more in our account (so for example we set aside so much each month for annual expenditures but for most of the year that money just sits in the account).

We also will be saving an additional £1000 per month to go into a pot for house improvements but this money could happily sit in the offset account.#

I can’t figure out if we’d be better with an offset mortgage. The best rate we can find is 4.18% with a fee of £1000. We spoke to a broker who said we’d be thousands worse off each year with an offset, but my calculations suggest otherwise. We are both higher rate tax payers and every month I seem to get emails telling me my savings interest rate is reducing yet again. The calculator on here I just cannot understand.

Just to clarify the savings - basically what's the average you'll have during the fixed term? 
* currently 60k saved after the purchase and all costs?
* 2k saved each month not needed for spending
* £x saved for annual expenditures - how much is that?
* £1k saved for house improvements
* Do you have any ISA allowances? 

Lets say you have £4k a month building up and then spent at the end of the year before you start again. So on average you have 24k savings at any given time, and at a 4% interest which you can get in the market, that's £960 interest, which is covered by the £500 each savings allowance without paying tax. If instead the money was in an offset mortgage account then there's also no tax so fairly equivalent. 

So now lets consider the £180k mortgage v £60k savings, assuming your savings allowance is fully used up and its a 3 year mortgage. 
Option 1: normal mortgage + savings
- 3.85% mortgage on 180k -> cost £20279 over 3 years (you'll gradually pay some off so the interest reduces)
- 4.5% savings on 60k -> at 40% tax rate, effective rate is 2.7% so gain £4,992 over 3 years with compounding
- £250 cash back
Total cost £15,036

Option 2: offset mortgage with 180 borrowed, 60k saved
- 4.16% mortgage on 120k net -> cost £14,608 over 3 years
- £1000 arrangement fee
Total cost £15,608

Option 3: Mortgage for 120k then remortgage to release 60k
- 3.85% mortgage on 120k -> cost £13,519
- £250 cashback 
Total cost £13,269

Basically (1) and (2) are fairly close. With an offset mortgage, you're paying more interest on the 120k, but then you get a slightly better saving on the 60k vs putting it in an easy access account and with the £1250 difference in fee v cashback, they end up similar. This assumes that the easy access rate stays the same - it may reduce a bit, but that will probably be covered by the £600 difference. 

The bigger differences come from if you have unused ISA allowances, in which case you can put money there tax free, or if you're comfortable with option (3) whereby you take a smaller mortgage for a shorter period. This only works if you think you'll be able to remortgage in 3 years time before you need the money for school etc. 

sink_or_swim

Brie said:

Well it sounds like you're talking about a mortgage of £180,250 at 3.85% versus £121,000 at 4.18% so my initial guess is you'd be better in the short term if you offset.  

The next bit that might affect this is what is the mortgage term?  If you have it set for 3 years then you can reconsider the situation when private school might start to require fees.  

Looking further -  £180,250 at 3.85% for 1 year is 6940 while £121,000 at 4.18% is 5058.  If you could get 4% on savings of £60k that would bring the cost of the first down to 4540.  That assumes you can maintain that rate which seems unlikely.  But offset you are saving on the mortgage interest rate of 4.18% so the more you save each month the better this will be.

Ultimately I don't see the difference being "thousands" like the broker is stating.  It's reasonably close call with the offset winning more as the rate on savings decreases.  

Thank you. 
The £250 is what we get back because we are buying a 'green' property, so really it's £179750, but that will make minimal difference I imagine.

Yes I very much doubt we could get 4% on savings. 

Both mortgage terms are 2 years, so you're absolutely right that we can reassess it - and we'd be able to do that before we were committing to school fees.

sink_or_swim

@saajan_12

Thank you so much for going through this in such detail.

To answer some of the questions:

Yes – we will have 60k left after purchase/solicitor/stamp duty/moving costs.

We will be able to save 2k per month that we shouldn’t need to dip into for anything unless there is a big house related emergency – like the roof caves in (which isn’t especially likely as the property is only 15 years old and in excellent condition)

We tend to save ~£1000 a month for those annual expenditures, but are pulling that money out in bits at various times throughout the year.

I think we’d have roughly £90000 average in savings across those 2 years based on the time points when big chunks would likely come out. The offset is only available for 2 or 5 years so I’m working on the basis of both offset and non-offset being2 years at the moment.

We have maxed out our ISAs for this year. Obviously we will get more allowance in April though. We aren't using any money in ISAs towards our deposit (and they are in addition the the 60k we will have spare). So I suppose in an absolute emergency we could always dip into this, though I don't want to lose that tax-free interest amount. But also, that 2k per month we are saving could easily go into an ISA.

It would be nice to think that the portion of our wages that sits in our current account while it’s waiting to pay our bills could be used to reduce mortgage costs, but in the grand scheme of things this would be a small proportion of the mortgage balance.

As ridiculous as it sounds, I hadn’t even considered only taking 120k, and then when we remortgaged borrowing more if we needed to! I will definitely consider this.