Offset mortgage - reduce term or reduce monthly payment and invest difference?

[dingdong]

Hi - I currently have an offset mortgage of 320k, with 270k in the savings account (i.e. net mortgage of 50k). I figured given the current high interest rates (and likely low returns from the stock market) it made sense to maximise the amount I'm offsetting for the next two years.

My rate is shortly going up from 1.35% to 4.98% (which means mortgage payments will now be around 2200 a month)

However I'm trying to get my head round whether to stick with the previous common approach of using the offset balance to reduce the overall mortgage term.

OR

Is it better to reduce the monthly payment dramatically...... then invest the difference into the stock market on a monthly basis..... on the basis that inflation is currently high and will be eating away at the real value of the mortgage balance - so why put so much money into repaying the mortgage over the next two years?

[chas49]

You have effectively a marginal savings rate of 4.98% - because every additional £ you pay off (by increasing the savings balance, or overpaying the mortgage) 'saves' you interest of 4.98%.

I think you are (or will be) overpaying by around £1100 a month? If I'm right about that, you could be fully offset (and then able to settle the mortgage) in 3.5 years.

Can you really be sure that your investments will beat that ca.5% rate over the short-term?

[Adamski]

People seem pessimistic at present on the forum, which on past evidence is usually the best time to invest! However..

The stock market has in broad terms been moving sideways for last two years. A new bull market could start once inflation has fallen and interest rate starts coming down. That's difficult to predict and could be more bad news if the earnings season is bad. So yeah, investing pretty uncertain versus certainty with your offset mortgage.

[DrFfybes]

It depends on a whole host of factors..... how long your mortgage has to run, whether you can overpay and if there is a limit r penalties, how easy you can transfer savings off the capital balance and whether it can be reversed, your age, your job security, your other savings, your pension, your risk profile, whether you have plans for the £270k equity, can you afford the new rate easily, are you thinking of retiring soon, or downsizing, do you have kids approaching college or wanting a house deposit you can take from your offset, etc.

It is a personal decision, and one not made purely on financial grounds.

For many people, us included, not having a mortgage was a great relief. It meant our money was ours, not at the mercy of an interest rate rise. For others the handy line of credit is desirable , either to leverage to invest, or if that is all the savings they have.

Your annual interest payments are going up from circa £4300to £15k, so £800+/month more. So what are you doing with that £800 now? It sounds like it is 'spare', so is it being invested?

If you are using it to live off, then move the offset to reduce the balance and the monthlies, then you keep the £800 to spend. If not then you have a range of options, either keep paying it to the mortgage effectively getting 5% tax free (which I suspect will beat the stockmarket this year), do as you say and invest it each month, or you could hedge your bets and do a bit of both.

But just to be clear, what your are talking about is either reducing a loan quickly, or slowing the reduction in order to invest more. This is effectively borrowing money at 5% (tax free) in order to invest it. Right now I'm not sure that is something I'd be doing.

Paul

[dingdong]

Thanks all - when you think about needing to beat 5% after tax it does make it seem hard to find a better use than leaving cash in the offset given the current outlook.

However - if you were at the point where your offset savings exactly matched the mortgage balance (but you didn't want to pay the full mortgage off early in case those funds were needed in the future for something)... would that change the equation and make it more clearcut?

ie. would it always make sense to then use the offset balance to reduce your monthly repayment amount (therefore delaying the point at which you payoff the mortgage), rather than reducing the term....... so that you get the benefit of extra cash in your pocket today whilst also allowing more time for inflation to reduce the real value of the mortgage balance??

[DrFfybes]

However - if you were at the point where your offset savings exactly matched the mortgage balance (but you didn't want to pay the full mortgage off early in case those funds were needed in the future for something)... would that change the equation and make it more clearcut?

ie. would it always make sense to then use the offset balance to reduce your monthly repayment amount (therefore delaying the point at which you payoff the mortgage), rather than reducing the term....... so that you get the benefit of extra cash in your pocket today whilst also allowing more time for inflation to reduce the real value of the mortgage balance??

Your mortgage may vary, but when we had an offset you only earnt equivalent interest rate up to the amount outstanding, once above that the interest rate on a nett credit balance was a lot lower. And taxed.

Paul.

[Gerry557]

I would have probably said yes to investing when the rate was 1.35% and inflation was eating away at it.

Now it's much more closer to call. I think DrFfybes covers most of the points well. You don't mention how long the offset has to run and any fix period. A 5 year fix or longer might aid with the investment route.

Look on the monivator Web site which had an article on the question you are asking. The next question then becomes how you do pay off the mortgage. Build up a pot (tax free share isa) and when it's equivalent pay it off or wait till a cliff edge date in the future. Do you use the income to add to the offsets over time leaving you with a smaller lump to find. There are lots of variations but you need an exit plan too.

Basically you need your return to be greater than the costs of the offset. It's possible with investments that average 7% but you need time on your side. Additionally how is your mind with investing. Are you going to be worried that your pot has fallen £80k in a week (covid, financial crisis) and sell up in a low to save what is left of the roof over your head. How much time would the Bank allow you to wait for things to turn around.

You could hybrid it by investing to cover the remaining outstanding amount, reducing your monthly outlay and investing that. Less of a risk and leaving you with a solid ish foundation.

Whilst I think it's still possible, I think the tables swung more against it. Generally if you had 30 years I'd still go for it if everything else was OK. On the limited info you provided probably not or just limited amounts.