Cut Years Off Your Mortgage Costs

How a flexible or offset mortgage could you help cut your mortgage costs this year.

Two million people are currently considering a mortgage payment holiday according to research released in December. And wouldn’t that be nice? A little extra in your bank account after the excesses of Christmas? Yes, we’d all like a break from mortgage payments.

But how can you get one?

Will lenders be open to the idea of you simply deciding to not pay up for a few months? The Government has already strong-armed banks and building societies into agreeing to defer interest payments for up to two years for struggling borrowers.

But there is another type of payment holiday that lenders are happy to give to all borrowers, as long as they have the right type of mortgage. Thank goodness for flexibility.

What is a flexible mortgage?

Flexible mortgages have been around since the early nineties but it wasn’t until around 2000 that mainstream lenders started to add some flexible features to their standard deals. Most lenders will now let you overpay on your homeloan (they would, wouldn’t they?) and an increasing number will let you take payment holidays.

But if you take out a fully flexible mortgage you get even more features such as:

The ability to underpay

The ability to borrow back overpayments

A flexible mortgage works like a normal mortgage and can be taken out on a repayment or interest-only basis and as a fixed, discounted or tracker rate.

But it allows you to have more control over how you repay your mortgage debt. If you have more money one month you can ‘overpay’ and reduce your outstanding debt. This immediately reduces the interest you are charged as flexible mortgages calculate interest daily. By paying less interest and more capital off each month you can cut years off your mortgage term, as our overpayment calculator demonstrates.

And if you have a tight month?

If you are struggling financially you can choose to ‘underpay’, ‘borrow back’ overpayments -- or take a ‘payment holiday’ where you skip a couple of payments. But your lender will usually insist that you have already overpaid the same amount to balance out your account, to stop you from falling into arrears.

For example, if you had overpaid £200 a month for a year you would have built up £2,400 in overpayments. If you do nothing this will reduce the amount of interest you have to pay on your debt, as well as your mortgage term. But if you decide to take a payment holiday you could skip payments up to £2,400 and still be on course to repay your debt in full at the end of the original term.

Flexibility is now available on many lenders’ standard deals -- Nationwide for example allows all borrowers to overpay up to £500 a month.

But some lenders, like Yorkshire Bank, offer specific flexible mortgages. With its Flexible Payment Mortgage you can make regular increased repayments or pay one-off lump sums. You can take payment holidays if you have made sufficient overpayments or take money back out of your mortgage if you have already overpaid in.

One step further

An offset mortgage goes one step further, offering borrowers extreme flexibility. You roll up all of the money you have in savings and overpay it into your mortgage.

For example, you might have a £150,000 mortgage that you pay 5% interest on and £20,000 in savings that you earn 3% interest on (and then that interest is taxed).

It would be more Foolish for you to simply pay interest on £130,000, saving 5% interest on £20,000, rather than earning 3%. You save the interest at the higher rate and earn nothing on your savings (so pay no tax which has particular advantages for higher rate taxpayers).

In other words you are charged the best interest rate possible for your whole finances, and some offset accounts enable you to roll in loans and current accounts too.

Because all of your money in credit is ‘effectively’ being overpaid into your mortgage (although it actually remains in a separate pot) your mortgage debt is smaller and you are therefore charged less interest.

So each monthly repayment is working harder, chipping away at the debt, since the interest is accounting for a smaller portion. Over the term of a mortgage this can save you thousands of pounds.

You can compare current offset mortgage deals using The Fool’s mortgage comparison service, and then calculate how much one of the deals would save you using our ever-so-clever offset mortgage calculator.

Who are these flexible products for?

They suit everybody, but those who have the money to overpay can really take advantage of them. And those with significant savings can see huge benefits from offsetting.

Does your job make a difference? Certainly, borrowers with varying income, such as salespeople, who can overpay in the good months and underpay when things are tight are also perfect for this type of mortgage, as are the self-employed, who save up their tax bill until January.

But really, anyone who wants to be able to control the way they manage their mortgage could benefit from looking into flexible and offsets mortgages.

The most important point is that flexible and offset mortgages are lifestyle choices, for people who want to manage their finances over a long period of time. They are not a way for borrowers who are struggling with their payments to be able to pay less each month, as lenders tightly control how much you are allowed to underpay.

And lenders are understandably tightening criteria in this area. Halifax recently stopped borrowers who have been made redundant taking payment holidays and Nationwide now requires borrowers to have equity of 25% before they can take skip a payment.

But for those who want the flexibility to pay more when they can or less when they want to, a flexible mortgage could be just the ticket.

Compare mortgages with Fool.co.uk