Be Careful With Offset Mortgages

There's a small chance that using an offset mortgage could put your savings at risk.

This article ignited some serious debate when it was first published earlier this month. Thanks to a few persistent Fools, we were inspired to continue checking and (re-checking!) the information that we were originally given by the Financial Services Compensation Scheme (FSCS).

This week, the FSCS has admitted that it misinformed us of the facts relating to offset mortgages while this article was being researched.

Therefore, the explanation of the rules relating to offset mortgages originally published in the article below is inaccurate.

The FSCS now states:

"If a bank were to go into default, the FSCS would consider the overall net claim. If the claimant's borrowings exceeded his/her savings, there would be no overall claim against the bank, and the claimant would not be entitled to any compensation.

 For example, if a customer had a mortgage of £200,000 and savings of £150,000 with the same bank, set-off would be applied to the example above by the Insolvency Practitioner dealing with the bank failure. As a result, the individual would end up owing the bank £50,000. There would be no positive balance and no claim.

 This cannot be assumed to apply to building societies, as there is no automatic set-off on insolvency".

We apologise for publishing misleading information in this article.

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Last month, I wrote about problems with the Financial Services Compensation Scheme.

At first glance, the scheme looks simple. If you have a savings account at a bank that goes bust, the FSCS will compensate your losses up to £35,000. So if you have, say, £100,000 in savings, it makes sense to split your cash into three chunks at separate banks.

Trouble is, some banks are linked, so even though you're saving with two apparently different banks, you may only get £35,000 from the FSCS.

As if this wasn't bad enough, I also pointed out that if you were borrowing from the bank at which you were saving, then your debt would be taken into account when your compensation was decided.

Several readers commented on the article and raised the question of how offset mortgages would be affected by the FSCS regulations.

I had hoped that the rules applicable to them might be slightly different.

After all, with an offset mortgage your savings and borrowing are linked together in a way that they aren't usually. What's more, the whole point of the product is that by amassing savings to the highest level you can, you benefit from paying less interest and can settle the balance of your mortgage more quickly.

But it turns out that my hope was a fool's hope - and not with a capital F.

So What Are The Rules?

Offset mortgage holders get no special treatment under FSCS regulations. This means that, if the bank went bust, people who currently hold savings of more than £35,000 against their mortgage debt could lose out.

Consider this example:

A couple have a mortgage of £135,000 on their home, offset by savings of £100,000.

Unexpectedly, their bank runs into difficulties and they become subject to FSCS rules. Only £35,000 of the couple's savings is guaranteed by the FSCS - but this sum is deducted from their outstanding mortgage, leaving them with a debt of £100,000.

Meanwhile, £65,000 of their savings (the portion not guaranteed by the FSCS) simply disappears. The only way for the couple to get it back is to go through the bank's liquidator.

It's chilling stuff.

What Are My Options?

This extra flaw in the FSCS does raise the question of what people with offset mortgages can do to ensure the safety of their savings. However, I must stress that the likelihood of any bank collapsing is very small.

The advantages of an offset mortgage can be significant, and I wouldn't advise anyone to give them up lightly.

By offsetting your savings against your mortgage, you can effectively save at the rate of the mortgage, tax-free. That means you could potentially cut years, and thousands of pounds, off the total cost of your mortgage.

Conversely, taking money out of your offset savings account will make it subject to normal tax rules, and will also increase the proportion of the mortgage debt on which you must pay interest.

So, using an offset mortgage to save more than £35,000 is effectively a question of whether you feel the benefits outweigh the risk.

If I had an offset mortgage with savings above that level, I might be tempted to pay a lump sum off my borrowing. Doing this would keep the money I'd built up safe, and I would still benefit from only paying interest on a comparatively small mortgage debt.

Alternatively, you could move savings above the £35,000 limit to other accounts - just be aware that you'll lose some of the benefits of offsetting. Also, don't forget to make sure that the accounts you choose for stashing your cash count as separate institutions under the FSA rules.

Personally, I think this is yet another failing of a scheme that's supposed to instill confidence in our financial institutions. Surely it's outrageous that a bank, in the unlikely event of its failure, should be able to swallow up your savings but still pursue you for repayment of a mortgage that was linked to them.

While the FSCS is currently under review, the document that sets out what will be assessed and potentially changed makes no specific mention of offset mortgages.

We at The Fool are calling for this issue to be carefully considered, so that the many people in this country who might benefit from offset mortgages can continue to do so, risk-free.

Why not use our Offset And Overpayment Calculator to see if you could benefit from an offset mortgage?

More:  Why Your Savings Might Be Unsafe | Compare Offset Mortgages At The Fool