Flexible loans can save you money

Offset mortgages can be cheaper for some borrowers, but they won't suit everyone, says Stephen Pritchard

Recent research carried out by pollsters ICM Research, on behalf of Intelligent Finance, suggested that borrowers in the UK pay as much as £2bn a year too much in mortgage interest. By taking out a flexible or "offset" mortgage, homebuyers could save thousands of pounds in interest, and pay off their home loans earlier.

Despite the appeal of paying back the mortgage ahead of time, only around 10 per cent of homebuyers currently opt for offset mortgages. Offsets work by setting money in linked savings accounts against the mortgage sum, with the borrower only paying interest on the balance. As long as the borrower keeps money in the linked savings accounts and does not take payment holidays, offsetting will enable them to pay back their loans early.

Take-up of flexible and offset mortgages is on the increase: Abbey, for example, says that 14 per cent of its borrowers opted for a flexible mortgage in the first five months of this year. That is double the rate in 2004. But across the industry, the majority of homebuyers still opt for a conventional mortgage, even though an offset mortgage should save money.

Possible explanations for this include the cost and the complexity of offset mortgages. Although Intelligent Finance claims that 44 per cent of adults are familiar with the principle behind offsetting, and that awareness has grown over the last few years, mortgage brokers say that few clients ask for offset home loans.

Cost is a big deterrent for many mortgage applicants, suggests David Hollingworth, a director at brokers London & Country. "Whilst an offset mortgage will pay off the loan more quickly, it does depend on having a significant proportion of the mortgage sum in savings," he says. "An offset mortgage can cost 0.75 per cent to 1 per cent more than a conventional mortgage, so you have to have a fair amount in savings to make it work."

The simplest and the most common offset account is a flexible mortgage - allowing under and over payments - with a linked savings account. The balance in the savings account is offset against the mortgage sum, cutting the total bill. Abbey's Flexible Plus mortgages, for example, can be set up this way.

More sophisticated offset loans link other accounts, in particular a current account, to the mortgage. This makes the buyer's money work harder, as any money in the current account reduces the mortgage interest, even if the money is only there for a day. Banks such the Clydesdale and the Norwich and Peterborough have such accounts.

Taking the idea one step further is the One Account, from Royal Bank of Scotland. This puts all funds into one single pot, including savings and current accounts. This is the purest form of an offset mortgage, but not all buyers like having their funds pooled in this way. There are other nuances to offsetting, too, such as Intelligent Finance's facility to link Isas to their offset mortgage account.

This complexity does give homebuyers choice, but there are also some drawbacks. Running an offset mortgage with a current account only works well for buyers who keep their accounts in credit. The more money in the current account, the greater the interest savings. Intelligent Finance calculates that an offset mortgage is only really worthwhile for homebuyers who borrow 85 per cent or less of their property's value, and pass at least £1,500 a month through their current accounts.

Nor do some buyers like the idea of tying up savings they have set aside for contingencies in a mortgage. "Most people like to have a rainy-day fund, but they almost have a fear of using that money to pay back the mortgage, even though it would be a wise move to make," says London & Country's Hollingworth.

An offset mortgage does, however, allow homeowners to take money out of the account without further form-filling or credit checks.

As a result, buyers who do opt for offsets tend to be those with quite complex and sophisticated financial arrangements. This includes buyers who have variable levels of income, perhaps including bonuses, and the self-employed, who may keep relatively large sums of money in savings accounts as a provision against future tax bills.