Rising interest rates - part 2

In last month’s article we considered alternative sources of business finance for your clients, to help them weather the storm created by recent interest rate rises. However, most of your business clients will also be homeowners, many with a mortgage or other personal borrowings.

In this article we consider how the relatively recent innovation of “offset” mortgages may be able to help SMEs, particularly sole traders.

How does offset work?
Offset mortgages, which originated in Australia, make use of two characteristics; firstly, the interest due is calculated on a daily basis and, secondly, they allow borrowers who also have savings with the lending bank to pay interest only on the difference between the mortgage balance and the value of monies held in current and savings accounts. In essence, someone with a mortgage of £100,000 and savings (&/or a current account balance) of, say, £20,000 will only be charged interest on the £80,000 difference. The “excess” paid each month immediately goes to pay off the principle of the loan. Anyone with a positive savings and current account balance will find that they repay their mortgage faster than originally scheduled.

There is also an option to make additional overpayments, either as a lump sum or on a regular basis, at any time, in which case the mortgage balance is repaid even faster. Again, the benefit of overpayment is immediate, rather than deferred until the end of the year as was the case with more traditional mortgages.

It is important to note that by using offsetting, the borrower is sacrificing interest on savings. However, there is no longer any tax relief on mortgage interest and the rate received on savings is almost invariably less than the level paid on a mortgage – especially when tax on interest received is taken into account. This means that most borrowers are likely to be far better off giving up interest on savings in order to reduce their overall mortgage costs.

Are there special benefits for SMEs?
Some lenders will allow sole traders who do their business banking with them to have positive balances included in the offsetting process, so that a small trader can actually use business balances – including their VAT account – further to reduce their mortgage balance. And, of course, the faster a mortgage is settled, the less interest is paid in the longer term.

How can this help when interest rates are rising?
At a time of rising interest rates, considering switching to a new form of borrowing that can actually carry a higher rate than other mortgage types may seem perverse. However, there can be good reasons for considering this option.

The reason is that offset lenders base monthly repayments on the actual amount lent (rather than the current outstanding balance) multiplied by the current interest rate. So if interest rates rise, so do repayments. But if the outstanding balance is smaller that the amount on which the repayments are based, then the “overpayment” each month will be greater, in monetary terms, the higher the interest rate. The difference might only be modest, but the faster the mortgage is repaid, the less interest is paid overall.

Where can my clients go for help?

We would be pleased to discuss your clients’ borrowing needs; please contact us.

YOUR HOME IS AT RISK IF YOU DO NOT KEEP UP THE PAYMENTS ON YOUR MORTGAGE.