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  • FIRST POST
    DiggingOut
    Offset Mortgages -- the Numbers
    • #1
    • 10th Jun 04, 7:08 PM
    Offset Mortgages -- the Numbers 10th Jun 04 at 7:08 PM
    Official MoneySavingExpert.com Insert: We now have an Offset Mortgage Calculator that should help with this.

    Back to the original post....

    --------------------

    This seems to be discussed a lot recently, on this board and the debts board.

    Lisyloo did a calculation a while back that showed you needed to have 48% of your mortgage amount in savings, although this was based on certain assumptions about relative rates.

    Since interest rates have moved on from there, I thought I would provide a formula which anyone can use to plug in real numbers at any time and make the calculation.

    To define terms:
    OffsetRate -- this is the interest rate you pay on an offset mortgage.
    NonoffsetRate -- the interest rate you pay on a non-offset mortgage (generally lower)
    SavingsRate -- this is the rate you can get on your savings (AFTER taxes) in a savings account if you don't have an offset mortgage
    X -- this is the breakeven point. !If you have more than X percentage in savings, you will be better off with an offset mortgage, less than X you are better off with a normal/flexible mortgage.

    The left side of the formula is the annual percentage interest you will pay with the offset mortgage. !The right side of the formula has two terms. !The first is the interest you will pay on your non-offset mortgage, the second is the interest you will receive on your savings.

    (100-X) * OffsetRate = 100 * NonoffsetRate – X * SavingsRate
    simplifying:
    100*OffsetRate – 100 * NonoffestRate= X * OffsetRate – X * SavingRate
    solving for X:
    X = 100 * (OffsetRate-NonoffsetRate) / (OffsetRate – SavingsRate)

    Obviously, the greater the difference between the rate of the offset mortgage and the best mortgage you could get otherwise, the higher the percentage has to be. !The more favourable your after tax savings rate, the higher the percentage has to be.

    One of the big advantages of an offset mortgage for some people is that they run very large amounts through their current account each month, and this is set off against their mortgage, even if only for just a few days. !Since current account rates are significantly lower than savings rates, to reflect this situation the formula has to be more complicated.

    Two more terms:
    CurAcctRate -- the interest rate you earn on your current account balance (AFTER tax) if you have a non-offset mortgage.
    Y -- the average collected balance in your current account over the course of the year, as a percentage of your mortgage balance.

    On to the formula:
    (100-X-Y) * OffsetRate = 100 * NonoffsetRate – X * SavingsRate – Y * CurAcctRate

    Solving for X:
    X = (100 * (OffsetRate-NonOffsetRate) + Y * (CurAcctRate-OffsetRate)) / (OffsetRate – SavingsRate)

    X is the break-even point for how much savings you need if you have an average current account balance of Y. !So you can plug in your own numbers.

    Solving for Y:
    Y = (100 * (OffsetRate – NonOffsetRate) + X * (SavingsRate – OffsetRate)) / (OffsetRate – CurAcctRate)

    This formula is for when you know how much savings you have (X) and are trying to determine what average balance you need in your current account to benefit from an offset mortgage. !Y is the break-even point -- more than Y, and you would benefit from the offset mortgage.

    Caveat:
    This obviously does not reflect differences in fees, the necessity to keep remortgaging to maintain the lowest rates, etc. !It compares non-flexible mortgages to offsets. !A flexible mortgage may be able to accomplish the same thing as an offset at lower price, if your money is in savings rather than your current account.

    This also does not reflect the intangible benefit of additional flexibility that an offset provides. ! It is simply for crunching the numbers. !It may be worth it to you, even if the numbers do not quite come down on the side of the offset, to pay slightly more for the extra flexibility.

    This also does not take into account at all where the money in savings comes from. !If you are a credit card tart and have significant funds from that source, it does not necessarily follow that they should be used on an offset or that they should be used on savings. !It is simply a matter of crunching the numbers to determine the best approach.

    Have fun!

    edit: corrected spelling error
    edit (9/7/04) clarified a couple of terms to prevent confusion.
    Last edited by Former MSE Andrea; 07-05-2011 at 8:46 PM.
Page 3
  • DiggingOut
    Re: Offset Mortgages -- the Numbers
    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.
  • showmethemoney
    Re: Offset Mortgages -- the Numbers
    Digging out

    Current savings rate - worked on the basis that my ING account gives me 4.85% gross and 2.8% net.

    I also have a cahoot account so we can use this for the calculation.

    Average current account balance - well I transfer any residual money from my current account to the ING/Cahoot account. So can we say that I will have an average of 1800 in the current account?

    I'm not married (but working on it :P - so cant offset anything to spouse.

    Also, I will not have anysavings once I buy the house, I will save approx 1800 a month after that from my salary.

    Is offset still better?

    Thanks for your help
  • DiggingOut
    Re: Offset Mortgages -- the Numbers
    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?
    Good point about decreasing balance, although few people who are thinking about this approach are really looking at a life of mortgage scenario. If someone is considering getting into an offset, they are typically thinking, "What is the best mortgage for me for the next 2-5 years?"

    For most people, there is not going to be a huge change in mortgage balance during that time, especially if they go with an offset -- overpayments would go into savings, not to reducing the balance.

    For someone who is in an offset and considering a change, the question is whether, right now, it is more beneficial for me to stay or to change.

    I don't think it is reasonable to try to construct formulas for changing mortgage balances/savings balances. That is spreadsheet work, which unfortunately I don't have the time to do.

    It probably makes sense to view the formula as stated as reflecting the current situation -- based on my savings today and mortgage balance today, an offset mortgage will be most beneficial (or not) for this year's interest costs.

    If looking at a set horizon, the average savings balance and average mortgage balance over that horizon would give a good approximation -- although changing interest rates dramatically change things, of course.

    If looking at the entire life of the mortgage, your estimate of the average balance being 1/2 of today's balance is reasonable, although the actual average will differ slightly.
  • DiggingOut
    Re: Offset Mortgages -- the Numbers
    I also have a cahoot account so we can use this for the calculation.
    OK, good. So we'll assume 3.3% (5.5 gross). Too bad you aren't married, it would have saved some tax (although it is rather expensive in other ways ;D).

    Average current account balance - well I transfer any residual money from my current account to the ING/Cahoot account. So can we say that I will have an average of 1800 in the current account?
    OK. And I'm assuming the current account rate you gave was gross, so an effective current account rate of 2.91%.

    And Y (% in current account) is 4.5%.

    savings breakeven point:
    X = (100 * (OffsetRate-NonOffsetRate) + Y * (CurAcctRate-OffsetRate)) / (OffsetRate SavingsRate)

    with your numbers
    X = (100 * (5.85-4.89) + 4.5 * (2.91-5.85)) / (5.85-3.3)
    = (100 * (0.96) + 4.5 * (-2.94)) / (2.55)
    = (96 - 13.23) / 2.55
    = 32.4%

    So savings over 32% means an offset is better for you.

    Also, I will not have anysavings once I buy the house, I will save approx 1800 a month after that from my salary.
    Now, this ties in very well to what David was saying here. You have no savings at all, so you are below the threshold of 32%. By the end of the first year, you will have savings of 55%. That means the first year, your average will be about 27% -- below the threshold. After about the seventh month the offset will be cheaper, but on average for the first year it will cost more. On average, for two years, it will be much less.

    Do you have to keep the savings liquid so you can get at them, or can you just make overpayments on your mortgage? If you can just make overpayments, I would be looking for the cheapest flexible mortgage you can find, and make those 1800 a month in overpayments. You will wipe out the mortgage very, very quickly that way -- less than two years.

    Flexible mortgages may not have the lowest rates, but they are typically lower than offset mortgages. In your case, I'd be looking at that very seriously.
    • Joe_Bloggs
    • By Joe_Bloggs 9th Aug 04, 5:17 PM
    • 4,493 Posts
    • 1,583 Thanks
    Joe_Bloggs
    Re: Offset Mortgages -- the Numbers
    @Dug and showmethemoney
    I made an edit to my post where I mentioned 0% credit cards could be used to temporarily fill a hole in savings. I managed to get 15000 this way in a month.
    If showmethemoney can save 1800 a month what has it been spent on in the past given no savings at present ? Surely a lifestyle change is called for.
    J_B (ever the sceptic.)
  • DiggingOut
    Re: Offset Mortgages -- the Numbers
    You skeptics are terrible. ;D

    He said "no savings after I buy the house." Clearly, the savings are going to a deposit, which is why he only needs a 50K mortgage.
    • Joe_Bloggs
    • By Joe_Bloggs 9th Aug 04, 6:33 PM
    • 4,493 Posts
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    Joe_Bloggs
    Re: Offset Mortgages -- the Numbers
    I'd hoped it was spent on foreign travel, fast sports cars and faster women and on general thrill seeking.
    Saving money for a house is nearly as bad as saving for a pension in terms of thrills!

  • DiggingOut
    Re: Offset Mortgages -- the Numbers
    Well, he didn't say WHO would be in the house, now did he?
    • david78
    • By david78 9th Aug 04, 10:15 PM
    • 1,637 Posts
    • 615 Thanks
    david78
    Re: Offset Mortgages -- the Numbers
    I don't think it is reasonable to try to construct formulas for changing mortgage balances/savings balances. That is spreadsheet work, which unfortunately I don't have the time to do.
    I quite agree. The question was asked tongue in cheek.
  • DiggingOut
    Re: Offset Mortgages -- the Numbers
    Sorry, I must be humour-deficient today. :

    edit: probably because I spent too much time down in MSA stringing beads together. :P
  • showmethemoney
    Re: Offset Mortgages -- the Numbers
    Easy boys!
    :P

    I'm a she not a he! !!!

    So no need to spend the money on fast women (already got a fast sports car .... although this is going in order to finance the house - doh). Maybe I'll be another fast sports car when the house is paid off!!!!

    However, JB you do have a point about "general thrill seaking" ........ :P

    Digging out - you are correct - savings are going towords the deposit.

    Thanks for all your help guys - its been invaluable.

    Off the get the best variable rate morgage with full flexiability to make overpayments tomorrow morning!

    Thanks again guys

  • DiggingOut
    Re: Offset Mortgages -- the Numbers
    I'm a she not a he! !!!
    ;D ;D ;D
    Bet you can find a guy to help you spend all that money so it doesn't have to go for boring things like paying off a mortgage.
  • showmethemoney
    Re: Offset Mortgages -- the Numbers
    ;D ;D ;D
    Bet you can find a guy to help you spend all that money so it doesn't have to go for boring things like paying off a mortgage.
    Is that an offer?

    J_B - just a thought, when you said you got 15k from credit cards in a month, was that in cash or was it for purchases? I thought CC worked on purchases, so I couldn't really use it towards offsetting the interest.
    • Joe_Bloggs
    • By Joe_Bloggs 10th Aug 04, 6:32 PM
    • 4,493 Posts
    • 1,583 Thanks
    Joe_Bloggs
    Re: Offset Mortgages -- the Numbers
    Do not try this before you get your mortgage.
    If your credit is good you can obtain 0% credit card deals and balance transfer funds without transaction penalties into current accounts.
    Many credit card companies do not allow this direct route so you have to balance transfer to a card that does. Egg, Mint and MBNA are very flexible money pipes and pretty good deals especially during introductory periods. Its all here thanks to Martin:-
    http://www.moneysavingexpert.com/cgi-bin/viewnews.cgi?newsid1076883546,34894,
  • DiggingOut
    Re: Offset Mortgages -- the Numbers
    Is that an offer? !
    Well, errrmmmm. :-/

    Yes, if you send me some money, I'll help you spend it by taking my wife on holiday. ;D

    Yes, you can borrow money on 0% credit cards, put it on a flexible mortgage, and then borrow it back when the 0% period is up. Or even transfer it to another 0% card.

    Some flexible mortgages don't allow you to borrow back once the balance is below 25K or so, so watch out for that -- you don't want to get a lot of borrowing on 0% cards, then have the introductory period run out and be charged 18% interest or something like that. :P
  • Hatties_mate
    Re: Offset Mortgages -- the Numbers
    ???
    I have an"offset mortgage" offer from Yorkshire bank. rate at the moment is 5.45% but is variable. We have very few savings (5k) but need a facility to borrow money against the house to pay school fees on a regular basis. Mortagae is aprox 200K and rising with 3k income going thru cheque a/c monthly. Currently with Bank of Scotland at a 5.5%rate with a facility to borrow more at this rate when nesc. Any help with the numbers would be appreciated.
    • Joe_Bloggs
    • By Joe_Bloggs 12th Aug 04, 11:02 PM
    • 4,493 Posts
    • 1,583 Thanks
    Joe_Bloggs
    Re: Offset Mortgages -- the Numbers
    @Hatties_mate
    Your post is buried here. Why not repost in a thread of your own in the main forum with a catchy title that describes your situation. If an offset is all you can get then so be it. They are not the best value if you have little savings in relation to what you borrow.
    Nobody is helping you here so you have nothing to lose by reposting. More financial details will be required to help those with the knowledge. Otherwise they will say contact a mortgage broker.
  • archived user
    Re: Offset Mortgages -- the Numbers
    In simple terms what is an offset mortgage?
    • lisyloo
    • By lisyloo 17th Aug 04, 1:27 PM
    • 25,523 Posts
    • 13,715 Thanks
    lisyloo
    Re: Offset Mortgages -- the Numbers
    Hi Judi,

    An offset mortgage is one where you have 2 account - one for the mortgage and one for savings (and possibly others as well but let's keep it simple).
    Basically you pay interest on the difference.
    For exmaple if you have a 100K mortgage and 20K savings then you pay interest on an 80K mortgage.

    This is advantageous because you pay NO TAX on your savings.
    However you have to balance this against the fact that the mortgage rates are higher than the cheapest discount/tracker mortgage.

    Calculations have shown that you need about 50% of you loan as savings to benefit compared with getting the cheapest discount mortgage (note this is a very general figure and depends on a number of factors - but gives you a ball park).

    There are also current account mortgages.
    These are similar but basically everything is in one account rather than several.
    This has the advantage that even your monthly salary can be saving you a few pennies in interest until you spend it.
    The psychological downside is that you have a large negative balance, but essentially they do the same as offset mortgages.

    Hope that helps and was simple enough
  • archived user
    Re: Offset Mortgages -- the Numbers
    Yes thanks, i understand.
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