How offset mortgages can help bonus-earners do Buy-to Let
Posted on 26 October 2018 by
What is an offset mortgage?
Offset mortgages began in Australia in the 1990s and when they first came to the UK they were affectionately called ‘Australian Mortgages’. At the time they were very new but relatively complicated and with several varieties. They have always been very flexible but until the last few years the difference in rates between them and traditional mortgages meant their take up wasn’t as high as lenders might have wanted. More recently their rates are much closer to traditional mortgage products so that now their benefits can be seen far more clearly.
Why choose an offset product over a normal mortgage?
At John Charcol we often deal with clients who are thinking of buying property in the future but want to get the borrowing plans laid out first. They may want a holiday home, or to start a buy to let portfolio, or may have extensive refurbishment plans. In these situations it could be that they just need initial funding or need access to the complete amount. Either way an offset mortgage can be the most efficient method.
The way it works is that the lender sets up a traditional mortgage that is linked to a savings account. Usually at the end of every day the credit balance of the savings account is subtracted from the balance outstanding on the mortgage account and interest is charged on this net balance. For example, if the mortgage is for £500,000 and you have £200,000 in the savings account then interest is charged on £300,000.
Up until this point there is a case to simply stick with a traditional mortgage since it is more familiar. But it is the potential usages for ‘offsetting’ that many do not necessarily see.
If you have equity in your main residence and a capacity to borrow then you could borrow the maximum you may need at the outset. Then immediately pay back any excess money you do not initially need into the savings account. This savings account accrues no interest, but all the time that money is in there you are not paying interest on it either. You are also not paying tax on interest which would be accrued if this money were to be held in a savings account. One day you decide to use that money (for a buy to let, holiday home etc) so you simply withdraw it from the savings account for any use you choose. It is at that point you start paying interest on the full amount of outstanding capital.
So let’s look at an example scenario we sometimes see at John Charcol. Mr & Mrs Campbell want to buy an investment property to rent out (or possibly as a home for their children while at university).
Their main residence is worth £900,000 and their existing mortgage is £150,000.
They need £400,000 to get a rental property some time in the near future. Both the Campbells work, but one receives sizeable annual bonuses. Their capacity to borrow is assessed at £600,000.
The recommendation could be to borrow £550,000 on an offset basis. The moment the mortgage completes there is £400,000 doing nothing but having interest charged. So the Campbells pay it straight back into the savings account. The net balance on the mortgage is now back down to £150,000.
Six months later they find a holiday home they want to buy for £350,000. They can move swiftly on the purchase as they are technically cash buyers. The amount is withdrawn from the offset savings account and transferred to their solicitor when required.
If one of the Campbell’s receives further bonuses they can put it into the savings account so that it further reduces the net balance on the mortgage – a saving that is likely to be higher than if placed in a deposit account. Also, since the holiday home or rental property is being purchased cash then it could be in one person’s name only for tax planning purposes. Furthermore, under current legislation, HMRC will normally allow the interest charged on funds raised on a main residence to be deducted from the rental income generated by a property purchased with those funds given an audit trail demonstrating where those funds originated. Your broker will advise that you consult with your qualified tax adviser to verify that aspect of the transaction.
These examples of potential uses do depend on various factors such as loan to value, affordability, interest rates, future income streams and current tax situations.
However, until explored, the full savings and usefulness are often missed. An independent broker will be able to assess your current situation and future needs and make an appropriate recommendation.
This article is for information only and does not constitute advice. Please obtain professional advice before taking out a mortgage. Your property may be repossessed if you do not keep up repayments on your mortgage, or any debt secured on it.
The blog postings on this site solely reflect the personal views of the authors and do not necessarily represent the views, positions, strategies or opinions of John Charcol. All comments are made in good faith, and John Charcol will not accept liability for them.