The Bank of England base rate has risen a staggering 2,900% since 14 December 2021 from 0.1% to 3%.  As a consequence interest rates on savings and mortgages have also risen.  However, the increase in interest rates on savings always seems to lag the increase in interest rates on borrowings.

Now that the base rate is returning to its historical average of c.4% over the 328 years history of the Bank of England it is making offset mortgages much more, well, interesting!  Why is this?  Well, let me illustrate what I mean by the use of a simple example.

 

 

Let’s say you have a bank mortgage of £100,000 and savings with various other banks, Building Societies and National Savings totalling, say, £50,000.  I will assume a mortgage interest rate of 5% and deposit account interest of 2%. It is assumed you are a 40% taxpayer.

Over 12 months you will pay £5,000 in mortgage interest.  You will receive £1,000 in interest on which you will pay £400 Income Tax.  Net cost to you is £4,400 (£5,000-£600).

If you were to convert your mortgage to an offset mortgage you would need to transfer all of your savings into an account with the same mortgage lender.  Assuming the interest rates remain the same the result is quite different.

 

 

 

With an offset mortgage, you offset the savings account balance, £50,000, against the mortgage account balance of £100,000.  The mortgage interest is calculated on the net balance of £50,000, not £100,000.  This makes a significant difference.

Your mortgage interest cost is reduced to just £2,500 (5% x £50,000).  

You do not receive interest on your savings.  However, you are, in effect, “earning” interest at a rate of 5% which is a much higher rate of interest than is available on the market.  Furthermore, it is effectively tax-free.  

The increase in interest earned is 317% (£2,500/£600) or a multiple of 4.17 times!

The overall net saving to you is 43% (£2,500 vs £4,400).

The other advantage of an offset mortgage is that you do not have to apply for a mortgage to raise funds for example for home improvements, holidays or car purchases.  All you need to do is transfer funds from your savings account to pay for things like you would with any bank account.  It is, in effect, a cheque book mortgage.

 

 

So a little skilful re-engineering of your finances can yield significant savings like this.  Repeat these kinds of personal financial exercises and you may be well on the way to improving your financial position greatly.  You know it makes sense.*

 

*Risk warnings

Your home may be repossessed if you do not keep up repayments on your mortgage. The contents of this blog are for information purposes only and do not constitute individual advice. You should always seek professional advice from a specialist.  All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.

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