A question about : Offset Mortgages -- the Numbers
Official MoneySavingExpert.com Insert: We now have an Offset Mortgage Calculator that should help with this.
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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.
Best answers:
- And I thought I was a number cruncher ;D
- There you go being polite again. I know what you really mean -- that anyone who would do that posting must be out of their mind! ;D
- Thankfully I no longer have an offset mortgage.
- Diggingout, excellent stuff thanks.
Using your calculation I notice that the difference in interest rates between offset and non-offset can make a HUGE difference to the money saving viability of offset mortgages – for the worse.
Especially as interest rates appear to be rising, the difference could increase as well.
I guess it also effectively ties up your savings for a long time (25 years) as if you spend it you may have a very expensive mortgage. - As I have mentioned on other threads
believe whilst offsetting does have its place- its of limited benefit to most with the current differences in offset account rates & variable trackers/discounts
Its heavily marketed - possibly as a way of lenders getting buisness in on products with higher profit margins. ( also in equity release)
Also broker commissions on offset accounts are often higher than on other types.
Some lenders are now ( at a fee) bringing in offset on their normal range. - It is an interesting debate, but I agree with digging out that there are more variables than just pure number crunching. Offset mortgages don't have tie-in penalties, make managing both debt and savings 'simpler' for alot of folk. The rate is usually very competetive against standard variable rates, which a majority of people end up sticking with once their discount has ended. It will be interesting to see what the average rates of offset mortgages rise to once the 'big' lenders have their quotas signed up. Switching from an offset has the added complication of maybe having to change your current account as well, which will be a big incentive to just stay'n'pay.
- What happended to all the offset mortgages that also had a hefty discount as well?
We are coming to the end of a 2yr 1.9% discount period of a offset/current account mortgage with mortgage trust ltd (formerly britannic money) that currently charges 4.29%.
There doesn't seem to be any comparable deals around which is a shame as it is very convenient having an offset but not if the rate is high! - I don't believe there are any good discount offset mortgages.
I haven't been following the market for long enough but I think that offsets have become less competitve with normal discount mortgages. - @Digging Out.
I could only get one mortgage and it was an IF tracker.
Intelligent Finance, or IF are a bonding of Halifax and Bank of Scotland, the non Royal kind, often refered to as HBOS. (Background for guests and the curious)
I had no credit history as I always saved my money for things I needed rather than use credit.
Your formula for my circumstances involves a division by zero as the rate I pay on my mortgage equals the rate I get on the cash balances in linked savings and current accounts.
Can you rearrange your formula to reflect the simplified circumstances. !
Regards JB
PS you are allowed to use the phrases 'trivial case' and
'by inspection'.
! - Joe - I am confused. Are you saying that your savings rate after tax is deducted is the same as the interest you are paying on your mortgage?
- @Pal
I don't pay any tax on my savings because I receive no interest on them. My 'savings' partially offset my mortgage capital before interest is charged on the mortgage.
I am free to use my savings as I see fit. It is very profitable to leave them to where they are.
I realise that there are better deals to be had but I had no real choice given my lack of credit history at the time. - So you are already offsetting. In that case the formula doesn't work as you are comparing the interest saving from offsetting with the notional interest earned by offsetting i.e. exactly the same thing. Obviously neither of these things is better.
Dug's formula is designed to show a comparison between offsetting and a savings account. - @Pal
I never knew I was doing anything different to anyone
else. I understand that DiggingOut's equations do not apply to me and that his equation could apply to anyone else with unlinked mortgage and savings, where the interest on the savings is liable for tax.
I leave it to the author of the equation to clarify the boundary conditions that apply.
PS I value your contributions and DiggingOuts enormously.
Regards JB. ! - J_B, the formulas do work for you, you just have to look at it kind of in reverse.
The purpose is to determine whether an offset mortgage or separate mortgage/savings products are to your advantage. Most people who would use the formula do not have an offset, they have savings and a mortgage. For them it is a question of whether they would gain by going to an offset.
In your case, you already have an offset, so the question is whether or not you would gain by going to separate products. To do this, you would have to be able to get another mortgage. You said IF was the only one you could get, but I suspect now you may be able to get another by virtue of having built up some history with your current mortgage.
So if you are thinking about remortgaging, you could look at what is available right now on mortgages (I haven't looked recently, so don't know). Then, you could compare it to what you would get on savings if you weren't in an offset mortgage (ISA, maybe 5.5% with cahoot, which would then need to be adjusted for tax). Plug those numbers into the formula along with your offset mortgage rate with IF and that should tell you whether you are better off with IF offset or by remortgaging to a low fixed rate or discount mortgage.
I hope all that is clear, if not please post again (with specific figures, if you want), and I'll try to clarify it more.
Very busy these days, so if you post more please also pm me to let me know, otherwise I may not see it for a few days.
Quote: - @DigggingOut
The status of existing financial products is not mentioned in your posts. Nor could it be as these vary from person to person. The title of the thread seems to apply to all offset mortgage products. Whether you ever had another mortgage before or not.
I know you missed out on the tax implications of mixing debts with savings and having them treated with the same interest rates by the same financial institution prior to taxation. I guess they could sack a few hundred staff after that simplification was made!
Don't let my pedantic protestations put you of from the great work that you do on the forum,.
Division by zero is infinity. Zero divided by zero is undefined. - J_B, if you check the thread which was referenced in my first post, it was a discussion as to whether or not an offset mortgage was worthwhile compared to other, cheaper mortgages. The prior calculation to which I referred was to determine the break-even point -- how much savings you have to have to make an offset mortgage more beneficial than another mortgage. If you check the link, I think you will see what I mean.
So the point of the calculations is to compare two scenarios -- offset and non-offset, by using offset rate vs. nonoffset rates (mortgage, savings, & current account). By using those rates, you can find the break-even point for how much savings you have to have to make an offset worthwhile. If your savings exceeds the breakeven point (on a percentage basis), the offset is more beneficial.
You should not assume that I missed out on tax implications without reading the definition of terms:
Quote: - @DiggingOut.
Tax = Ј0
You pay interest on the difference between your mortgage debt and your savings. You are never credited with interest. Hence you do not pay tax on your 'savings' pot. The rate is the same for both!
Hence tax implications are not a consideration for you to worry about. You just have to pay them off before Mervyn King has his way.
Regards JB
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