Personal Finance & Money Asked on February 25, 2021
I’m a contractor in the UK (working short term jobs that end from 6 months to a year althought my current contract has been for 3 years). I’d like to be able to take out a mortgage with a monthly payment I could manage even if I was out of work for a while but also be able to pay it off quicker when things are good.
My dad is also willing to lend me £100k. The ideal option seems to be an offset mortage I can put the borrowed money and extra money into.
Are there downsides to offset mortgages and no fees for early repayment? Is it worth it?
Discussions of current mortgage products would be out of scope, so this is a general answer.
Offset mortgages are indeed appealing in theory. In practice, it almost always comes down to rate.
Whenever I have looked at offsets, the rates and fees simply haven't been competitive versus the cost of borrowing and saving at the 'best buy' rates with different accounts.
Perhaps they are competitive in marginal cases. And as you may know UK mortgage products are exceedingly multi faceted. You have initial fees, different LTV bands, early repayment charges, flexible features (such as overpayment – and the facility to withdraw amounts previously overpaid, which, if available, may be as good as an offset mortgage). So it is very much down to not only the products, but your own circumstances, the amounts involved, and your ability to qualify based on credit scoring and the individual lender’s affordability rules.
One other factor has dealt a blow to the competitiveness of offset mortgages:
It used to be that savings interest had basic rate deducted at source. Therefore any interest “earned” by reducing your mortgage interest, rather than earned in its own right, used to have an immediate tax advantage. In other words, for every £1 spared in interest on your debt, you were £1 better off, versus 80p better off if you had been credited the interest minus basic rate tax in a savings account.
This situation was changed by the introduction of the Personal Savings Allowance. Since April 2016 basic rate taxpayers have been allowed to earn up to £1,000 tax-free per year in interest from a savings account. This is equivalent to 0.5% interest on a £200,000 loan. Therefore the tax efficiency of reducing your debt interest as opposed to earning credit interest has been neutralised for a lot of situations.
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Correct answer by marktristan on February 25, 2021
I'm also a contractor.
For us, the advantage of an offset mortgage is that you can keep access to your savings in case of lean times for business, while also reducing your mortgage payments. This gives you the benefits of overpaying without actually parting with the money.
That might be worth paying a premium for an offset, but it depends on how you trade and what your income is. If you use a PAYE umbrella or are employed on fixed term employment contracts, it might be worth it, as your "warchest" will be part of your personal finances. If you trade using your own limited company, then it's better by far to keep your "warchest" inside the limited, especially if drawing that money instead would put you into the higher rate tax band. By leaving it in the company until you need it, you defer the income tax until the year you actually draw the money.
Another factor to consider when deciding whether to overpay on a mortgage, especially if you are under 40, is the lost opportunity to instead invest that money in a pension. Pension contributions are (subject to contribution limits), tax free. This make a huge difference to their ROI compared with any investment made from taxable income, especially when your income would otherwise exceed the higher rate tax threshold. Because of compounding, a relatively modest return on that investment of 5% per year turns £1000 into £3207 after 20 years. Compared against the saving you make by overpaying on what is probably the cheapest loan you'll ever have, it's a no brainer IMO, as long as you're happy with the risk.
Counter intuitive though it may sound, if you are paying higher rate tax and wanted to buy a car or something similar, it would be more cost effective by far to borrow that money at a low rate of interest and make repayments from income in the basic rate band, than it would be to pay cash from income you'd paid 40% tax on. I guess that's the difference between debt and leverage.
Everyones particular circumstances, objectives and attitude to risk are different though, so there is no cookie cutter answer here. Spending a few hundred to discuss your circumstances and attitude to risk with an IFA would almost certainly be a wise investment. Also, have a look at the contractor uk forums, there are plenty of folks on there that will help with questions like these.
Answered by AnotherPenguin on February 25, 2021
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